Operating Cash Flow Versus Production Levels
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Consider a 2-year project with the following information: initial fixed asset investment = $495,000; straight-line depreciation to zero over the 2-year life; zero salvage value; selling price = $39; variable costs = $20; fixed costs = $210,000; quantity sold = 150,000 units; tax rate = 31 percent.
How sensitive is Operating Cash Flow (OCF) to changes in quantity sold? State your answer in terms of a dollar amount change (increase or decrease) in OCF for every additional unit sold.
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Solution Summary
The problem explains how operating cash flows are sensitive to production levels.
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The sensitivity of the Operating Cash Flow depends upon the relationship between the dollar amount of fixed costs and the total number of units sold.
Variable costs change only as units are made and or sold. However, fixed costs remained unchanged (fixed) no matter if 1 unit or 200,000 units are sold ($210,000 per year in this example). Because the dollar amount of fixed costs is low relative to the number of units sold in this example, the sensitivity of the Operating Cash Flow relative to this is pretty high.
If, for example, the fixed costs here were $2,000,000 for 150,000 units sold many, many more units would have to be sold in order to impact the operating cash flow significantly. However, since the ratio here is close to 1 (1.4:1, actually), the OCF is pretty sensitive.
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