MC algo 9-26 Calculating OCF

Bad Company has a new 4-year project that will have annual sales of 8,600 units. The price per unit is $20.10 and the variable cost per unit is $7.85. The project will require fixed assets of $96,000, which will be depreciated on a 3-year MACRS schedule. The annual depreciation percentages are 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. Fixed costs are $36,000 per year and the tax rate is 22 percent. What is the operating cash flow for Year 3?

Question

MC algo 9-26 Calculating OCF

Bad Company has a new 4-year project that will have annual sales of 8,600 units. The price per unit is $20.10 and the variable cost per unit is $7.85. The project will require fixed assets of $96,000, which will be depreciated on a 3-year MACRS schedule. The annual depreciation percentages are 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. Fixed costs are $36,000 per year and the tax rate is 22 percent. What is the operating cash flow for Year 3?

BlackTom AI · Accepted Answer

Question restatement: Bad Company has a new 4-year project with annual sales of 8,600 units at $20.10 per unit and variable cost per unit of $7.85. Fixed costs are $36,000 per year. Initial fixed assets are $96,000, depreciated on a 3-year MACRS schedule with annual percentages 33.33%, 44.45%, 14.81%, and 7.41%. Tax rate is 22%. What is the operating cash flow (OCF) for Year 3?

Option 1: $85,301
To reach a value this high, one might miscalculate by either understating depreciation or misapplying the tax impact. If you subtract variable costs and fixed costs from revenue, you get a large pre-tax operating profit, but forgetting to subtract depreciation in the taxable income or miscomputing tax would inflate the after-tax figure. Check whether depreciation is being subtracted in EBIT before applying tax and whether depreciation is subsequently added back to derive OCF.

Option 2: $62,567
This number could come from using a simplified OCF formula that adds back depreciation once, or from incorrectly treating taxes on EBIT without considering depreciation’s effect on taxable income. It’s essential to compute taxable income accurately as Revenue minus Variable minus Fixed minus Depreciation, then apply tax and add back depreciation to obtain OCF. A small error in one of these steps can push the result toward this value.

Option 3: $57,221
A plausible correct path: compute Revenue = 8,600 × 20.10 = 172,860. Compute Variable Costs = 8,600 × 7.85 = 67,510. Contribution-minus-fixed before depreciation = 172,860 − 67,510 − 36,000 = 69,350. Subtract Year 3 depreciation = 96,000 × 0.1481 = 14,217.6 to get taxable income = 55,132.4. Taxes at 22% = 12,129.128. Net income = 55,132.4 − 12,129.128 = 43,003.272. Add back depreciation (a non-cash charge) of 14,217.6 to arrive at OCF = 57,220.872, i.e., about $57,221. Paying attention to the exact depreciation rate and rounding leads to this figure.

Option 4: $59,373
This value might result from using the correct tax on EBIT but with a slightly different treatment of depreciation timing or rounding, or by inadvertently adding back depreciation twice or omitting a portion of fixed costs in the pre-tax computation. It’s close but would require revisiting whether the depreciation deduction was handled in taxable income and whether the final addition of depreciation back to after-tax income was performed exactly once.

Option 5: $18,385
An interpretation yielding such a small OCF would imply an error like neglecting either revenue or variable costs, or treating depreciation and taxes in a way that dramatically undercuts operating cash flow. It’s not consistent with the standard OCF calculation for this set of numbers, where revenue and contribution are substantial relative to fixed costs and depreciation.

Notes on the calculation logic: The conventional approach for OCF is to determine EBIT as Revenue minus Variable minus Fixed minus Depreciation, compute taxes on EBIT, obtain Net Income, and then add back Depreciation to convert to cash flow terms. With the given Year 3 depreciation of 14,217.6, the arithmetic yields an OCF around $57,221. Be mindful of rounding steps when presenting final dollar figures, as small changes can shift the result by a few dollars.

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