Question

Please disregard the increase/ and or decrease options that have been preselected. I selected them myself and am not sure of their accuracy.

A project currently generates sales of $10 million, variable costs equal to 50% of sales, and fixed costs of $2 million. The firm's tax rate is 35%. a. What are the effects on the after-tax profits and cash flow, if sales increase from $10 million to $11 million. (Input all amounts as positive values. Do not round intermediate calculations. Enter your answers in millions rounded to 3 decimal places.) by $ by $ After-tax profitincreased Cash flow increased million million b. What are the effects on the after-tax profits and cash flow, if variable costs increase to 65% of sales. (Input all amounts as positive values. Do not round intermediate calculations. Enter your answers in millions rounded to 3 decimal places.) After-tax profit decreased by $ by $ 748 million. Cash flow million. (Click to select)

Answer 1

a). Revenue increases by $1 million; which means variable costs increase by $0.5 million(i.e., 50% of Sales)

All other costs are unaffected.

So, Change in Before-tax Profit = Change in Revenues - Change in Expenses

= $1 million - $0.5 million = $0.5 million

Change in After-tax Profit = Change in Before-tax Profit * (1 - t)

= $0.5 million * (1 - 0.35) = $0.325 million

So, After-tax profit increase by $0.325 million

Cash Flow changes by an equal amount because depreciation is unaffected.

b). Variable Costs increased by 15% of Sales, i.e., 0.15 * $10,000,000 = $1,500,000

So, Change in Before-tax Profit = Change in Revenues - Change in Expenses

= $0 million - $1.5 million = -$1.5 million

Change in After-tax Profit = Change in Before-tax Profit * (1 - t)

= -$1.5 million * (1 - 0.35) = -$0.975 million

So, After-tax profit decrease by $0.975 million

Cash Flow changes by an equal amount because depreciation is unaffected.