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 28,000 tons of machine screws annually for automobile production. You will need an initial $5,800,000 investment in threading equipment to get the project started; the project will last for 6 years. The accounting department estimates that annual fixed costs will be $1,400,000 and that variable costs should be $265 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 6-year project life. It also estimates a salvage value of $775,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $380 per ton. The engineering department estimates you will need an initial net working capital investment of $560,000. You require a return of 14 percent and face a tax rate of 25.

a. What is the percentage change in OCF if the units sold changes to 29,000? (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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? v ENG 05-14 06-03-2020 23 CU21 CO CR CS CT CU CV CW CX CY CZ DA DB D C D D DE DETROIT DEPRECIATION = 966666.67 (5800000/6] STEP 1 OCF =( (sp-vc)(units) - fixed cost)(1-t) + t(depreciation) OCF =((380-265)(28000) - 1400000)(1-0.25) + (0.25)*(966666.67) OCF = 1606666.67 STEP 2 OCF =((sp-vc)(units) - fixed cost)(1-t) + t(depreciation) OCF = ( (380-265)(29000) - 1400000)(1-0.25) + (0.25)*(966666.67) OCF = 1692916.67 ANS 1 % CHANGE IN OCF = 5.3683% [(1692916.67-1606666.67)/1606666.67] ANS 2 DOL = DOL DOL = 1 + (FIXED COST(1-t) - DEPRECIATION(t))/OPERATING CASH FLOW 1 + (1400000(1-0.25) - (966666.67*0.25)/1606666.67 1.5031 ... NPV NEW MACHINE yen dollar hege payback irr BEST WORST PRICEQUANTITY OCF ACC BE, CASH BE, FIN BE BASE CASE SENSITIVITY :