A project currently generates sales of $21 million, variable costs equal 50% of

Question

A project currently generates sales of $21 million, variable costs equal 50% of sales, and fixed costs are $4.2 million. The firm’s tax rate is 35%. Assume all sales and expenses are cash items.

a. What are the effects on cash flow, if sales increase from $21 million to $23.1 million? (Input the amount as positive value. Enter your answer in dollars not in millions.)

b. What are the effects on cash flow, if variable costs increase to 65% of sales? (Input the amount as positive value. Enter your answer in dollars not in millions.)

Explanation / Answer

Current Sales = $21 million

Variable cost = 50% of sales = 0.5*21 = $10.5 million

Fixed cost = $4.2 million

Tax rate = 35%

Profit before tax = 21 - 10.5 - 4.2 = $6.3 million

Profit after tax = 6.3*(1-0.35) = $4.095 million

a) If sales increase to $23.1 million then variable cost = 0.5*23.1 = $11.55 million

Fixed cost = $4.2 million

Profit before tax = 23.1 - 11.55 - 4.2 = $7.35 million

Profit after tax = 7.35*(1-0.35) = $4.7775 million

If sales increase from $21 million to 23.5 million then cash flow will increase by 4.7775-4.095 = $0.6825 million = 0.6825*1000000 = $682,500

b). If variable costs increase to 65% of sales then variable cost = 21*0.65 = $13.65 million

Profit before tax = 21-13.65-4.2 = $3.15 million

Profit after tax = 3.5*(1-0.35) = 2.0475 million

So cash flow will decrease by 4.095-3.15 = $0.945 million = 0.945*1000000 = $945000

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