Question

If we consider the effect of taxes, then the degree of operating leverage can be written as:

  

DOL = 1 + [FC × (1 – TC) – TC × D]/OCF

  

Consider a project to supply Detroit with 27,000 tons of machine screws annually for automobile production. You will need an initial $5,000,000 investment in threading equipment to get the project started; the project will last for 5 years. The accounting department estimates that annual fixed costs will be $1,200,000 and that variable costs should be $225 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 5-year project life. It also estimates a salvage value of $575,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $332 per ton. The engineering department estimates you will need an initial net working capital investment of $480,000. You require a return of 11 percent and face a tax rate of 22.

  

a.	What is the percentage change in OCF if the units sold changes to 28,000? (Do not round intermediate calculations and enter your answer as a percent rounded to 4 decimal places, e.g., 32.1616.)
b.	What is the DOL at the base-case level of output? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Answer 1

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