consider a four year project with the following information: initial fixed asset investment=420,000;staright-line depriciation to zero over the four year life; zero salavage value; price=25; variable cost=16; fixed cost=180,000; quantity sold=75,000 units; tax rate= 34 percent. how sensitive is ocf to changes in quantity sold.
To determine how sensitive the Operating Cash Flow (OCF) is to changes in quantity sold, we need to calculate the OCF for different quantities and observe how it changes. Here are the steps to calculate the OCF and analyze its sensitivity:
Step 1: Calculate the OCF:
The formula to calculate OCF is as follows:
OCF = (Quantity Sold * (Price - Variable Cost) - Fixed Costs) * (1 - Tax Rate)
In this case, the given values are:
Initial Fixed Asset Investment = $420,000
Straight-line depreciation to zero over four years
Zero salvage value
Price = $25
Variable Cost = $16
Fixed Cost = $180,000
Quantity Sold = 75,000 units
Tax Rate = 34%
So, we can calculate the OCF using the above formula:
OCF = (75,000 * (25 - 16) - 180,000) * (1 - 0.34)
OCF = (75,000 * 9 - 180,000) * (1 - 0.34)
OCF = (675,000 - 180,000) * (1 - 0.34)
OCF = 495,000 * 0.66
OCF = $326,700
Step 2: Calculate the OCF for different quantities:
Now, you can repeat the OCF calculation for various quantity values to observe how it changes. For example, you can try calculating the OCF for 70,000 units, 80,000 units, and so on.
Step 3: Analyze the sensitivity:
To analyze the sensitivity, compare the OCF values for different quantities and observe how much they change. You can calculate the percentage change in OCF for each quantity using the formula:
Percentage Change in OCF = ((OCF2 - OCF1) / OCF1) * 100%
Where OCF2 is the OCF for a different quantity and OCF1 is the original OCF (obtained from the given quantity).
By calculating the percentage change in OCF for different quantities, you can determine how sensitive the OCF is to changes in quantity sold. The greater the percentage change, the more sensitive the OCF is to quantity variations.