In: Finance
Consider a project with a life of 3 years with the following
information: initial fixed asset investment = $350,000;
straight-line depreciation to zero over the 3-year life; zero
salvage value; price = $34; variable costs = $12; fixed costs =
$133,000; quantity sold = 59,850 units; tax rate = 22 percent. How
sensitive is OCF to changes in quantity sold?
Step 1 : Calculation of Operating Cash Flows
Particulars | Amount |
Nos of Units sold | 59,850 |
Contribution @22 pu. | $1,316,700.00 |
Less: Fixed Cost | ($133,000.00) |
Less: Depreciation | ($116,666.67) |
Income before tax | $1,067,033.33 |
Less: Tax @22% | ($234,747.33) |
Income after tax | $832,286.00 |
Add: Depreciation | $116,666.67 |
Operating CF | $948,952.67 |
Notes :
1 Contribution pu = Sale Price - Variable Cost = $34-$12 = $22
2. Calculation of Depreciation on Fixed Asset
Cost of Fixed Asset | $350,000.00 |
Life | 3 years |
Depreciation | $116,666.67 |
Step 2 :For sensitivity analysis we need to evaluate the impact of change on operating cash flows due to the change in quantity sold.
Now lets assume the quantity sold reduces by 10%
Revised quantity = 59,850*90%= 53,865
Calculation of operating cash flows at reduced level of Quantity Sold (53,865 units)
Particulars | Amount |
Contribution @22 pu. | $1,185,030.00 |
Less: Fixed Cost | ($133,000.00) |
Less: Depreciation | ($116,666.67) |
Income before tax | $935,363.33 |
Less: Tax @22% | ($205,779.93) |
Income after tax | $729,583.40 |
Add: Depreciation | $116,666.67 |
Operating CF | $846,250.07 |
It can be notice that there is decrease in Operating cash flows as we reduce the number of units sold.
Step 3: Evaluation of Sensitivity
Sensitivity/Change in Operating cash flows = (948952.67-846250.07)/948952.67 =10.82%
Operating cash flows decrease (%)= 10.82%