We are evaluating a project that costs $1,675,000, has a six-year life, and has

Question

We are evaluating a project that costs $1,675,000, has a six-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 91,000 units per year. Price per unit is $35.95, variable cost per unit is $21.40, and fixed costs are $775,000 per year. The tax rate is 35 percent, and we require a return of 11 percent on this project.

What is the sensitivity of OCF to changes in the variable cost figure?

Sensitivity of OCF ------> $.................

If there is a $1 decrease in estimated variable costs, how much would the increase in OCF be?

Increase in OCF ------> $.................

We are evaluating a project that costs $1,675,000, has a six-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 91,000 units per year. Price per unit is $35.95, variable cost per unit is $21.40, and fixed costs are $775,000 per year. The tax rate is 35 percent, and we require a return of 11 percent on this project.

What is the sensitivity of OCF to changes in the variable cost figure?

Sensitivity of OCF ------> $.................

If there is a $1 decrease in estimated variable costs, how much would the increase in OCF be?

Increase in OCF ------> $.................

Explanation / Answer

OCF=(91,000*35.95 - 91,000 * 21.40 - 775,000)(1-0.35) + 0.35*(1,675,000/6) = $454,591

OCF=(91,000*35.95 - 91,000 * 20.40 - 775,000)(1-0.35) + 0.35*(1,675,000/6) = $513,741

Thus, the change in OCF per unit change in VC is

Sensitivity=($454,591 - $513,741)/(21.40-20.40)=-59,150

That is, OCF decreases by $59,150 for every dollar increase in VC

b)

For a $1 decrease in VC, OCF increases by

Change in OCF =1*59,150=$59,150

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