Use the results of Problem 26 to find the degree of operating leverage for the company in Problem 27 at the base-case output level of 20,000 tons. How does this number compare to the sensitivity figure you found in Problem 28? Verify that either approach will give you the same OCF figure at any new quantity level.

Problem 27

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3.1 million investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $925,000 and that variable costs should be $185 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $400,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $295 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. You require a return of 13 percent and face a tax rate of 22 percent on this project.