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Basic

(continued )

Intermediate

(Questions 16-22)

PART FOUR Capital Budgeting

11. Calculating Operating Leverage At an output level of 30,000 units, you calculate that the degree of operating leverage is 3. If output rises to 36,000 units, what will the percentage change in operating cash flow be? Will the new level of operating leverage be higher or lower? Explain.

12. Leverage In the previous problem, suppose fixed costs are $150,000. What is the operating cash flow at 35,000 units? The degree of operating leverage?

13. Operating Cash Flow and Leverage A proposed project has fixed costs of $30,000 per year. The operating cash flow at 7,000 units is $63,000. Ignoring the effect of taxes, what is the degree of operating leverage? If units sold rises from 7,000 to 7,300, what will be the increase in operating cash flow? What is the new degree of operating leverage?

14. Cash Flow and Leverage At an output level of 10,000 units, you have calculated that the degree of operating leverage is 3.5. The operating cash flow is $9,000 in this case. Ignoring the effect of taxes, what are fixed costs? What will the operating cash flow be if output rises to 11,000 units? If output falls to 9,000 units?

15. Leverage In the previous problem, what will be the new degree of operating leverage in each case?

16. Break-Even Intuition Consider a project with a required return of R% that costs $I and will last for N years. The project uses straight-line depreciation to zero over the N-year life; there is no salvage value or net working capital requirements.

a. At the accounting break-even level of output, what is the IRR of this project? The payback period? The NPV?

b. At the cash break-even level of output, what is the IRR of this project? The payback period? The NPV?

c. At the financial break-even level of output, what is the IRR of this project? The payback period? The NPV?

17. Sensitivity Analysis Consider a three-year project with the following information: initial fixed asset investment = $420,000; straight-line depreciation to zero over the three-year life; zero salvage value; price = $26; variable costs = $18; fixed costs = $185,000; quantity sold = 110,000 units; tax rate = 34 percent. How sensitive is OCF to changes in quantity sold?

18. Operating Leverage In the previous problem, what is the degree of operating leverage at the given level of output? What is the degree of operating leverage at the accounting break-even level of output?

19. Project Analysis You are considering a new product launch. The project will cost $680,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $19,000, variable cost per unit will be $14,000, and fixed costs will be $150,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 35 percent.

a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios?

b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs.

c. What is the cash break-even level of output for this project (ignoring taxes)?

d. What is the accounting break-even level of output for this project? What is the degree of operating leverage at the accounting break-even point? How do you interpret this number?

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