Question

1. Wolverine Widgets considering a new investment that has projected unit sales in year 1 of 1,000 units. The sales price per unit is $80, variable costs are 60% of sales, and fixed costs are $200,000; depreciation is 75,000, and the tax rate is 21 percent.
   1. What is the projected operating cash flow for year 1?[4 points]

2. What is the Depreciation Tax Shield in year 1? [3 points]

3. How sensitive is the operating cash flow to a $1 change in the per unit sales price? [3 points]

4. You feel that both sales and variable costs are accurate to +/- 15%. What is the annual operating cash flow for the best-case scenario? [3 points]

Answer 1

Information given in the question:

Number of Units Sold in year 1 = 1,000

Sales price per unit = $80

Variable costs per unit = 60% of sales price = 60% * $80 = $48

Fixed Costs = $200,000

Depreciation per annum = $75,000

Tax rate = 21%

a. Projected operating cash flow for year 1

Total Sales = Number of units sold * Sales price per unit = 1,000 * $80 = $80,000

Total variable cost = Number of units sold * variable cost per unit = 1,000 * $48 = $48,000

Fixed cost = $200,000

Operating cash flow = Sales - Variable Cost - Fixed Cost = $80,000 - $48,000-$200,000 = -$168,000 (Cash-outflow)

Please note that Operating cash flow will not include depreciation and the tax shield of depreciation.

b. Depreciation Tax Shield in year 1

Tax shield = Depreciaton * tax rate = $75,000 * 21% = $15,750

c. Sensitivity of the operating cash flow to a $1 change in the per unit sales price.

Assume Sale price increases by $1 from $80 to $81. Then Variable cost which is 60% will be $48.6 ($81*60%)

Fixed cost will not change.

Hence revised operating cash flow = Sales - Variable Cost - Fixed Cost

= (1000 units * $81) - (1000 units * 48.6) - $200,000 = $81,000-$48,600-$200,000 = -$167,600

Change in operating cash flow = $168,000 - $167,600 = $400 or 0.24% ($400/$168,000).

Thus for every $1 increase in sale price, operating cash flow improves by $400 or by 0.24%.

d. annual operating cash flow for the best-case scenario

Best case for Sale price = current price + 15% increase = $80 * (100%+15%) = $92

Best case for variable cost = current % of sale price - 15% decrease = 60% * (100-15%) = 51% of sale price

Best case scenario operating cash flow = Sales - Variable Cost - Fixed Cost

= (1000 units * $92) - (1000 units * ($92*51%)) - $200,000 = $92,000-$46,920-$200,000 = -$154,920