Ch.

11

25. a. The tax shield definition of OCF is:

OCF = [(P v)Q FC](1 TC) + TCD
Rearranging and solving for Q, we find:
(OCF TCD)/(1 TC) = (P v)Q FC
Q = {FC + [(OCF TCD) / (1 TC)]} / (P v)

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b.

The cash breakeven is:

QC = {$500,000 + [($0 700,000(.38)) / (1 .38)]} /

($40,000 20,000)
QC = 3.55
And the accounting breakeven is:
QA = {$500,000 + [($700,000 700,000(.38)) / (1 .
38)]} / ($40,000 20,000)
QA = 60
The financial breakeven is the point at which the
NPV is zero, so:
OCFF = $3,500,000 / PVIFA20%,5
OCFF = $1,170,328.96
So:
QF = [FC + (OCF TCD)/(1 TC)]/(P v)
QF = {$500,000 + [$1,170,328.96 .38($700,000)] /
(1 .38)}/ ($40,000 20,000)
QF = 97.93 98
c.At the accounting breakeven point, the net income is
zero. Thus using the bottom up definition of OCF:

CHAPTER113

OCF = NI + D
We can see that OCF must be equal to depreciation.
So, the accounting breakeven is:
QA = {FC + [(D TCD) / (1 TC)]} / (P v)
QA = (FC + D) / (P v)
QA = (FC + OCF) / (P v)
The tax rate has cancelled out in this case.
26.

The DOL is expressed as:

DOL = %OCF / %Q
DOL = {[(OCF1 OCF0)/OCF0] / [(Q1 Q0) / Q0]}
The OCF for the initial period and the first period is:
OCF1 = [(P v)Q1 FC](1 TC) + TD
OCF0 = [(P v)Q0 FC](1 TC) + TD
The difference between these two cash flows is:
OCF1 OCF0 = (P v)(1 TC)(Q1 Q0)

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Dividing both sides by the initial OCF we get:

(OCF1 OCF0)/OCF0 = (P v)( 1 TC)(Q1 Q0) / OCF0
Rearranging we get:
[(OCF1 OCF0) / OCF0] / [(Q1 Q0) / Q0] = [(P v)(1
TC)Q0] / OCF0 =
[OCF0 TCD + FC(1 TC)] / OCF0
DOL = 1 + [FC(1 TC) TCD] / OCF0
27.

a. Using the tax shield approach, the OCF is:

OCF = [($280 185)(35,000) $985,000](1 .
38) + .38($5,200,000 / 5)
OCF = $1,846,000
And the NPV is:
NPV = $5,200,000 410,000 +
$1,846,000(PVIFA13%,5)
+ [$410,000 + $500,000(1 .38)] / 1.135
NPV = $1,273,596.06

b. In the worst-case, the OCF is:

OCFworst = {[($280)(.9) 185](35,000) $985,000}
(1 .38) + .38[$5,200,000(1.15) / 5]

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OCFworst = $1,297,680
And the worst-case NPV is:
NPVworst = $5,200,000(1.15) $410,000(1.05) +
$1,297,680(PVIFA13%,5) +
[$410,000(1.05) + $500,000(.85)(1 .38)] /
5
1.13
NPVworst = $1,469,583.94
The best-case OCF is:
OCFbest = {[$280(1.1) 185](35,000) $985,000}(1
.38) + .38[$5,200,000(.85) / 5]
OCFbest = $2,394,320
And the best-case NPV is:
NPVbest = $5,200,000(.85) $410,000(.95) +
$2,394,320(PVIFA13%,5) +
[$410,000(.95) + $500,000(1.15)(1 .38)] /
1.135
NPVbest = $4,016,776.07
28. To calculate the sensitivity to changes in quantity
sold, we will choose a quantity of 36,000 tons. The
OCF at this level of sales is:

CHAPTER116

OCF = [($280 185)(36,000) $985,000](1 .38) + .

38($5,200,000 / 5)
OCF = $1,904,900

CHAPTER117

The sensitivity of changes in the OCF to quantity sold

is:
OCF/Q = ($1,846,000 1,904,900) / (35,000
36,000)
OCF/Q = +$58.90
The NPV at this level of sales is:
NPV
=
$5,200,000

$410,000
+
$1,904,900(PVIFA13%,5) + [$410,000 + $500,000(1 .
38)] / 1.135
NPV = $1,480,760.98
And the sensitivity of NPV to changes in the quantity
sold is:
NPV/Q = ($1,273,596.06 1,480,760.98) / (35,000
36,000)
NPV/Q = +$207.16
You wouldnt want the quantity to fall below the point
where the NPV is zero. We know the NPV changes
$207.16 for every ton sold, so we can divide the NPV
for 35,000 units by the sensitivity to get a change in
quantity. Doing so, we get:

CHAPTER118

$1,273,596.06 = $207.16(Q)
Q = 6,148
For a zero NPV, we need to decrease sales by 6,148
units, so the minimum quantity is:
QMin = 35,000 6,148
QMin = 28,852
29. At the cash breakeven, the OCF is zero. Setting the
tax shield equation equal to zero and solving for the
quantity, we get:
OCF = 0 = [($280 185)QC $985,000](1 .38) + .
38($5,200,000 / 5)
QC = 3,659
The accounting breakeven is:
QA = [$985,000 + ($5,200,000 / 5)] / ($280 185)
QA = 21,316
From Problem 28, we know the financial breakeven is
28,852 tons.

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30. Using the tax shield approach to calculate the OCF,

the DOL is:
DOL = 1 + [$985,000(1 .38) .38($5,200,000 / 5)] /
$1,846,000
DOL = 1.12
Thus a 1 percent rise in Q leads to a 1.12 percent rise in
OCF. If Q rises to 36,000, then
the percentage change in quantity is:
Q = (36,000 35,000) / 35,000 = .0286, or 2.86%
So, the percentage change in OCF is:
%OCF = 2.86%(1.12)
%OCF = 3.19%
From Problem 28:
OCF/OCF = ($1,904,900 1,846,000) / $1,846,000
OCF/OCF = .0319, or 3.19%
In general, if Q rises by 1,000 tons, OCF rises by
3.19%.

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