Question

A project currently generates sales of $16 million, variable costs equal 50% of sales, and fixed costs are $3.2 million. The firm’s tax rate is 40%. Assume all sales and expenses are cash items.

a. What are the effects on cash flow, if sales increase from $16 million to $17.6 million? (Input the amount as positive value. Enter your answer in dollars not in millions.)

Cash Flow____ by____

b. What are the effects on cash flow, if variable costs increase to 60% of sales? (Input the amount as positive value. Enter your answer in dollars not in millions.)

Cash Flow____ by____

Answer 1

Given,

Sales = $16 million or $16000000

Variable cost rate = 50% of sales

Fixed cost = $3.2 million or $3200000

Tax rate = 40% or 0.40

Solution :-

Variable cost = $16000000 x 50% = $8000000

Cash flow = (Sales - variable cost - fixed cost) x (1 - tax rate)

= ($16000000 - $8000000 - $3200000) x (1 - 0.40)

= $4800000 x 0.60 = $2880000

(a)

New sales = $17.6 million or $17600000

New variable cost = $17600000 x 50% = $8800000

Cash flow = (New sales - new variable cost - fixed cost) x (1 - tax rate)

= ($17600000 - $8800000 - $3200000) x (1 - 0.40)

= $5600000 x 0.60 = $3360000

Increase in cash flow = $3360000 - $2880000 = $480000

Cash flow increases by $480000

(b)

Variable cost rate = 60% of sales

New variable cost = $16000000 x 60% = $9600000

Cash flow = (sales - new variable cost - fixed cost) x (1 - tax rate)

= ($16000000 - $9600000 - $3200000) x (1 - 0.40)

= $3200000 x 0.60 = $1920000

Decrease in cash flow = $2880000 - $1920000 = $960000

Cash flow decreases by $960000.