Question

A project currently generates sales of $10.5 million, variable costs equal to 40% of sales, and fixed costs of $2.2 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 $10.5 million to $12 million. (Input all amounts as positive values. Do not round intermediate calculations. Enter your answers in millions rounded to 3 decimal places.) After-tax profit (Click to select) by Cash flow (Click to select) by $ million million. b. What are the effects on the after-tax profits and cash flow, if variable costs increase to 60% 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 (Click to select) by $ Cash flow [Click to select) by $ million. million

Answer 1

a). Revenue increases by $1.5 million; which means variable costs increase by $0.6 million(i.e., 40% of Sales)

All other costs are unaffected.

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

= $1.5 million - $0.6 million = $0.9 million

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

= $0.9 million * (1 - 0.35) = $0.585 million

So, After-tax profit increase by $0.585 million

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

b). Variable Costs increased by 20% of Sales, i.e., 0.20 * $10,500,000 = $2,100,000

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

= $0 million - $2.1 million = -$2.1 million

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

= -$2.1 million * (1 - 0.35) = -$1.365 million

So, After-tax profit decrease by $1.365 million

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