value 100 points If we consider the effect of taxes then the

value 1.00 points If we consider the effect of taxes, then the degree of operating leverage can be written as: DOL = 1 +[FC x(1-TC)-TcxDJ/OCF Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production You will need an initial $5,400,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $850,000 and that variable costs should be $450 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $380,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $560 per ton. The engineering department estimates you will need an initial net working capital investment of $540,000. You require a return of 12 percent and face a marginal tax rate of 38. 3 2 a. What is the percentage change in OCF if the units sold changes to 41,000? (Do not round intermediate calculations. Enter your answer as a percent rounded to 4 decimal places, e.g. 32.1616.) 7% ercentage change in OCF b. What is the DOL at the base-case level of output? (Do not round intermediate calculations and round your final answer to 4 decimal places, e.g.. 32.1616.) DOL References eBook & Resources

Solution

a. OCF in case of 40,000 units

= [(560-450)*(40,000) – 850,000]*(1-38%) + 38% of (5,400,000/6)

= $2,543,000

If units sold = 41,000 then OCF = [(560-450)*(41,000) – 850,000]*(1-38%) + 38% of (5,400,000/6)

= $2,611,200

% change in OCF = (2611200-2543000)/2543000

= 2.6819%

b. Base case level of output = 40,000.

DOL = 1+[850,000*(1-0.38) – (0.38*5,400,000)/6]/2,543,000

= 1 +0.0727

= 1.0727