In: Finance
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
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