Question

DOL=1+[FC (1-To-TC× DVOCF

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3.1 million investment in threading equipment to get the project started, the project will last for five years. The accounting department estimates that annual fixed costs will be $925,000 and that variable costs should be $185 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $400,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $295 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. The tax rate is 22 percent.
a. What is the DOL at the base-case level of output? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What is the percentage change in OCF if sales increase to 21,000 tons? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

The Degree of Operating Leverage (DOL) is calculated using fixed costs, the tax rate, and the degree of variable costs. For the given scenario, the DOL and the percentage change in Operating Cash Flow (OCF) should be computed using these variables and the change in sales volume.

Step-by-step explanation:

To calculate the Degree of Operating Leverage (DOL), we must first understand that it measures a company's operating leverage, which reflects the extent to which fixed costs are used in a company's operations. The DOL formula is:

DOL = 1 + (Fixed Costs × (1 - Tax Rate) ÷ (1 - Degree of Variable Cost per Output))

From the data provided, we can determine the fixed cost (FC), the tax rate (To), and the degree of variable cost per output. Using the provided selling price ($295 per ton) and the variable cost ($185 per ton), we can calculate the contribution per unit as $110 (selling price less variable cost). The number of units sold is 20,000 tons.

Fixed cost (FC) = $925,000
Tax rate (To) = 22%
Degree of variable cost per output (DVOCF) = Variable costs ÷ Selling price per unit = $185 ÷ $295

Therefore, the DOL can be calculated as:

DOL = 1 + [$925,000 * (1 - 0.22) ÷ (1 - $185 ÷ $295)]

For the percentage change in operating cash flow (OCF) if sales increase to 21,000 tons, we calculate the OCF at 20,000 tons and 21,000 tons, then find the percentage increase from the initial OCF.

Operating cash flow is calculated as:
OCF = (Sales - Variable Costs - Fixed Costs) * (1 - Tax Rate) + Depreciation

We can calculate OCF for both 20,000 and 21,000 tons sold and then find the percentage change using the formula:

Percentage change in OCF = [(OCF at 21,000 tons - OCF at 20,000 tons) ÷ (OCF at 20,000 tons)] * 100