Stellar Plastics is analyzing a proposed project with annual depreciation of $19,500 and a tax rate of 34 percent. The company e
xpects to sell 12,000 units, plus or minus 5 percent. The expected variable cost per unit is $3.20 plus or minus 4 percent, and the expected fixed costs are $30,000 plus of minus 2 percent. The sales price is estimated at $7.50 a unit, plus or minus 4 percent. What is the operating cash flow for a sensitivity analysis using total fixed costs of $31,000
if you use an excel spreadsheet you can calculate all the different possible simulations and combine all the expected sales x 3 different price levels x 3 different variable costs and 1 fixed cost. Once you get all the 27 possible solutions, you just get the average.
To solve this exercise we will use the "High Low Method" which is a technique that allows to determine the costs associated with a certain level of activity, identifying its fixed and variable elements. This is done by taking the two most "extreme" data (the highest and the lowest) from a data set.
We will follow these steps:
1. Identify the data set:
90% occupancy $ 200,000 450
80% occupancy $ 197,000 400
Because it is a 500-unit apartament complex, with an occupancy level of 90%, it means that there are 450 units in operation, and with an occupancy level of 80%, 400.
A 50% occupancy level implies that there are 250 units in operation. Therefore, we want to find the total cost associated with the maintenance of these units.
2. Identify the extreme data.
According to the data set, the most extreme are:
The highest cost is $ 200,000 and the highest number of units is 450.
The lowest cost is $ 197,000 and the lowest number of units is 400.
3. Calculate the variable cost per unit.
For this we follow the following formula
Where HC = Highest Cost, LU= Lowest Cost, HU = Highest number of Units, LU = Lowest number of Units.
VCU = $ 60 per unit.
4. Calculate the fixed cost
Any level of activity is chosen. Here we will choose the highest: 450 units that operate at a cost of $ 200,000. Although we could choose the 400 units that operate at $ 197,000. It does not matter which one.
Now what we do is apply the following formula:
Where HC = Highest Cost, VCU = Variable Cost per Unit, HU = Highest number of Units.
FC = 200,000 - ($ 60 * 450)
FC= 200,000 - (27,000)
FC = 173,000
5. Calculate the total variable cost of the new activity
We multiply the Variable Cost per Unit ($ 60) by the number of units that will operate at a 50% occupancy level (250)
Variable cost of the new activity = $ 60 * 250
Variable cost of the new activity = $ 15,000
6. Calculate the total cost
The fixed cost ($ 173,000) and the total variable cost of the new activity ($ 15,000) are added