Question

New Co. has a DOL of 1.5.   They predicted sales of 10,000 units, but it may be more like 12,000 units.  If the OCF at the expected level is $1,000,000, what would you expect OCF to be at the higher level?

1. $1,200,000
2.    1,300,000
3.       700,000
4.    1,500,000
5.   None of the above.

1. If the initial investment in a six year project is $400,000 and the IRR is 18%, what is the annual income?

1. $114,364
2.      66,667
3.    108,206
4.    150,015
5.      83,500

1. In using the MACRS depreciation method:

1. Each percentage is divided by the cost of the asset.
2. Year three is always where the huge tax savings occurs.
3. The sum of the percentages does not always add up to 100%.
4. Each percentage is multiplied by the cost of the asset
5. Book value is important in the computation of depreciation.

2. XYZ Co.’s sales are $250,000, costs are $130,000, depreciation is $25,000 and the tax rate is 21%.  What is operating cash flow?

1. $100,050
2.     94,800
3.   145,000
4.    19,950
5.    None of the above

Answer 1

1. Ans . b) $1,300,000

Explanation:

Degree of operating leverage (DOL) = 1.5
Expected sales = 10,000 units
Operating Cash Flows (OCF) at the expected level = $1,000,000
Expected Increased Sales =  12,000 units.
Let OCF to be at the higher level = X

Formula:
DOL = Percentage change in operating income / Percentage change in sales

1.5 =  (X -$1,000,000)/ $1,000,000 / (12,000-10,000)/10,0000
1.5 = (X -$1,000,000)/ $1,000,000 / 0.2
0.3 = (X -$1,000,000)/ $1,000,000
$300,000 = (X -$1,000,000)
X = $1,300,000

OCF to be at the higher level = $1,300,000

2. Ans. a) $114,364

Explanation:

Initial investment = $400,000
IRR = 18%
Project life = 6 years

Calculation of  Annual Income

IRR is the rate of return at which NPV = 0
NPV = Present value of Cash inflows - Present Value of Cash Outflows
0 = Present value of Cash inflows -  $400,000
Present value of Cash inflows = $400,000

Annual Income = Present value of Cash inflows / PVAF (IRR, t)
Annual Income = $400,000 / PVAF (18%, 6)
Annual Income = $400,000 / 3.49760256
Annual Income = $114,364.05

3. Ans. d) Each percentage is multiplied by the cost of the asset

Explanation: MACRS is the depreciation system followed in U.S. Here, cost of tangible property is distributed over a specified life. The life of the assets and depreciations rates are specified in IRC. Reasons why other options are False are as follows:

a) Each percentage is divided by the cost of the asset.
False, Each percentage is multiplied by the cost of the asset.
b) Year three is always where the huge tax savings occurs.
False, no the depreciation rate is highest in year 2. Therefore, year 2 is where huge tax savings occur.
c) The sum of the percentages does not always add up to 100%.
False, The sum of the percentages always add up to 100%.
e) Book value is important in the computation of depreciation.
False, Original Cost of the asset is used to calculate the depreciation.

4. Ans.a) $100,050

Explanation:
Calculation of Operating cash flows

Particulars	Amount
Sales	$250,000.00
Less: cost	$(130,000.00)
Less: Depreciation	$(25,000.00)
Profit before tax	$95,000.00
less: Tax @ 21%	$(19,950.00)
Profit after tax	$75,050.00
Add: Depreciation	$25,000.00
Operating cash flows	$100,050.00

Note :
PVAF = (1/(1+r))^1 + (1/(1+r))^2 +...+(1/(1+r))^n
or you can use Present value factor tables