BASIC INFORMATION: A three-year project will cost $60,000 to construct. This will be depreciated straight-line to zero over the three-year life. The price per unit sold is $20 and the variable cost per
Unit sold is $10. Fixed costs are $30,000 per year.
Using the BASIC INFORMATION only, if you expect to sell 7,000 units per year, what is the OCF in
Year 2 assuming a required return of 15% and a tax rate of 30%?
A) $17,000
B) $20,000
C) $34,000
D) $48,000
E) $55,000

Question

Quizplus · Accepted Answer

To calculate OCF in Year 2, we need to first calculate the annual depreciation expense, which is $60,000/3 years = $20,000 per year.

Next, we can calculate the annual revenue: 7,000 units per year x $20 per unit = $140,000.

Variable costs will be: 7,000 units per year x $10 per unit = $70,000.

Fixed costs are given as $30,000 per year.

So, the pre-tax profit for Year 2 is: ($140,000 - $70,000 - $30,000 - $20,000) = $20,000.

To calculate OCF, we need to adjust for taxes and add back depreciation:

OCF = ($20,000 x (1-0.3)) + $20,000 = $14,000 + $20,000 = $34,000.

Therefore, the best choice is C.

BASIC INFORMATION: a Three-Year Project Will Cost $60,000 to Construct