Question

In: Finance

Consider a 3-year project with the following information: initial fixed asset investment = $420,000; straight-line depreciation...

Consider a 3-year project with the following information: initial fixed asset investment = $420,000; straight-line depreciation to zero over the 3-year life; zero salvage value; price = $29; variable costs = $16; fixed costs = $197,400; quantity sold = 78,960 units; tax rate = 35 percent. How sensitive is OCF to changes in quantity sold? (Do not round your intermediate calculations.)

A) $6.00

B) $0.12

C) $10.90

D) $9.63

E) $8.45

Expert Solution

First, we calculate the OCF at 78,960 units as below :

depreciation per year = initial investment / 3

income before tax = revenue - VC - FC - Depreciation

OCF = Income before tax - taxes

Year	Investment	Revenue	Variable Cost	Fixed Cost	Depreciation	Income before taxes	Taxes	OCF
0	($420,000.00)
1		$2,289,840.00	($1,263,360.00)	($197,400.00)	($140,000.00)	$689,080.00	($241,178.00)	$447,902.00
2		$2,289,840.00	($1,263,360.00)	($197,400.00)	($140,000.00)	$689,080.00	($241,178.00)	$447,902.00
3		$2,289,840.00	($1,263,360.00)	($197,400.00)	($140,000.00)	$689,080.00	($241,178.00)	$447,902.00

OCF at 78,960 output is $447,902

Next, we calculate the OCF at 79,961 units of output :

Year	Investment	Revenue	Variable Cost	Fixed Cost	Depreciation	Income before taxes	Taxes	OCF
0	($420,000.00)
1		$2,289,869.00	($1,263,376.00)	($197,400.00)	($140,000.00)	$689,093.00	($241,182.55)	$447,910.45
2		$2,289,869.00	($1,263,376.00)	($197,400.00)	($140,000.00)	$689,093.00	($241,182.55)	$447,910.45
3		$2,289,869.00	($1,263,376.00)	($197,400.00)	($140,000.00)	$689,093.00	($241,182.55)	$447,910.45

OCF at 78,961 output is $447,910.45

sensitivity of OCF to changes in output = change in OCF / change in output = (447,910.45 - 447,902) /1 ==> 8.45

The answer is E

jeff jeffy answered 1 year ago

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