4. A project with fixed costs of 320,000 and operating cash flow of 160,000 was
ID: 1169894 • Letter: 4
Question
4. A project with fixed costs of 320,000 and operating cash flow of 160,000 was expected to sell 11,000 units. The final results for the year were that 9,800 units were sold instead.
What is the degree of operating leverage? __________________
What is the percentage change in quantity? _________________
What is the percentage change in operating cash flow? ________________
What would the operating cash flow be under the actual level of production? __________________
7. Colby is in the furniture moving business. He has some equipment that he purchased new two years ago for $6,000. At the time, Colby’s accountant told him to depreciate it straight line over three years. Now there is better equipment out there and he wants to get rid of his old machine, but he can get only $700 for it. Colby is in the 35% tax bracket.
What is the book value of the old machine? __________
What is the market value of the old machine? _________
Will Colby have a gain or loss? _____________
How much will his gain or loss be? ____________
What will be the tax effect (amount)? ____________
What is the after tax salvage value of the old machine? _______________
8. A certain asset was purchased at a cost of $1,140,000. This company is in the 35% tax bracket. Complete the lines below:
Year MACRS % Amount of Dep Amount of Dep Difference Tax Effect
under MACRS under straight line
1 .3333 ______________ ________________
2 .4444 ______________ ________________ ______________ ______________
3 .1482 ______________ ________________
4 .0741 ______________
9. Frugal Company is considering two machines for purchase. The machine is integral to their business, so when it wears out, it will be replaced with a similar machine. The company uses a discount rate of 9% for their investments. Compute the equivalent annual cost of each machine.
Machine A Machine B
Initial cost 219,000 188,000
Useful Life 14 years 13 years
Annual maintenance 1,500 per year 2,000 per year
EAC of A _____________ EAC of B ______________ Which should Frugal choose? ______________
A or B
Explanation / Answer
4. Operating leverage= Contribution/(Contribution-Fixed Cost)=4,80,000/(4,80,000-3,20,000)=3 times
Percentage change in quantity=(11,000-9,800)/11,000=0.1091 or 10.91%
Percentage change in operating cash flow=(1,60,000-1,07,636)/1,60,000=0.3273 or 32.73%
Operating cash flow for 9,800 units=4,80,000*9,800/11,000-3,20,000=$1,07,636
7. Book value of old machine= 6,000(1-2/3)=$2,000
Market value of old machine= $700
Colby will have a loss since market value is less than book value.
Capital loss=$(2,000-700)=$1,300
Tax savings on capital loss=$1,300*35%=$455
After tax salvage value of old machine= $(700+455)=$1,155
8. Because of not having knowledge about MACRS system of depreciation I am unable to answer this question.
9. For Machine A, annual maintenance=$1,500 per year having useful life of 14 years
Initial investment=$2,19,000
PVAF(9%.14)=7.7862
Equivalent initial investment=$2,19,000/7.7862=$28,126.69
EAC of A= $(1,500+28,126.69)=$29,626.69
For Machine B, annual maintenance=$2,000 per year having useful life of 13 years
Initial investment=$1,88,000
PVAF(9%.13)=7.4869
Equivalent initial investment=$1,88,000/7.4869=$25,110.53
EAC of B= $(2,000+25,110.53)=$27,110.53
Thus Frugal should choose Machine B.
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