Question

If we consider the effect of taxes, then the degree of operating leverage can be written as: DOL = 1 + [FC * (1 - Td-TCD]/OCF Consider a project to supply Detroit with 28,000 tons of machine screws annually for automobile production. You will need an initial $4,800,000 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 $1,150,000 and that variable costs should be $215 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 $525,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $320 per ton. The engineering department estimates you will need an initial networking capital investment of $460,000. 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.) X Answer is complete but not entirely correct. % a. b. Change in OCF DOL 4.9763 1.6425

Answer 1

DOL=1+(FC*(1-Tc)-Tc*D)/OCF
=1+(1150000*(1-25%)-25%*4800000/5)/((28000*(320-215)-1150000-4800000/5)*(1-25%)+4800000/5)
=1.393364929