Question

If we consider the effect of taxes, then the degree of operating leverage can be written as: DOL = 1 + [FC × (1 – TC) – TC × D] / OCF Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $4,000,000 investment in threading equipment to get the project started; the project will last for three years. The accounting department estimates that annual fixed costs will be $700,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the three-year project life. It also estimates a salvage value of $440,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $320 per ton. The engineering department estimates you will need an initial net working capital investment of $400,000. You require a return of 11 percent and face a marginal tax rate of 30.

a. What is the percentage change in OCF if the units sold changes to 31,000?

b.	What is the DOL at the base-case level of output?

Answer 1

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