McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 1175874 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $820 per set and have a variable cost of $420 per set. The company has spent $152,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,700 sets of its high-priced clubs. The high-priced clubs sell at $1,120 and have variable costs of $720. The company will also increase sales of its cheap clubs by 11,200 sets. The cheap clubs sell for $460 and have variable costs of $240 per set. The fixed costs each year will be $9,120,000. The company has also spent $1,130,000 on research and development for the new clubs. The plant and equipment required will cost $28,840,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,320,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 10 percent.
Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained or lost are uncertain.) (A negative answer should be indicated by a minus sign. DO NOT ROUND INTERMEDIATE CALCULATIONS and round your answers to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Normal Upper Bound + 10% Lower Bound - 10% Unit Sales 56,000 61,600 50,400 Price $820 $902 $738 Variable Costs $420 $462 $378 Fixed Costs $9,120,000 $10,032,000 $8,208,000 Sales lost (expensive) 9,700 10,670 8,730 Sales gained (cheap) 11,200 12,320 10,080 Base Case Best Case Worst Case Unit Sales 56,000 61,600 50,400 Price $820 $902 $738 Variable Costs $420 $378 $462 Fixed Costs $9,120,000 $8,208,000 $10,032,000 Sales lost (expensive) 9,700 8,730 10,670 Sales gained (cheap) 11,200 12,320 10,080 Best Case Sales New clubs = $902× 61,600 $55,563,200 High-priced clubs = $1120 x -8730 -$9,777,600 Cheap clubs = $460 x 12320 $5,667,200 Total sales $51,452,800 Variable costs New clubs = $378 × 61,600 $23,284,800 High-priced clubs = $720 x -8730 -$6,285,600 Cheap clubs = $240 x 12320 $2,956,800 Total Variable costs $19,956,000 Pro forma income statement Sales $51,452,800 Less: variable cost -$19,956,000 Less: Fixed cost -$8,208,000 Less: Depreciation = $28,840,000/7 -$4,120,000 EBT $19,168,800 Taxes @ 35% -$6,709,080 Net Income $12,459,720 OCF = NI + Depreciation $16,579,720 Initial Investment $28,840,000 Add: working capital $1,320,000 Total cash flow in year 0 $30,160,000 NPV Year Cash flow PV @ 10% Present Value 0 -$30,160,000 1 -$30,160,000 1 $16,579,720 0.909090909 $15,072,472.73 2 $16,579,720 0.826446281 $13,702,247.93 3 $16,579,720 0.751314801 $12,456,589.03 4 $16,579,720 0.683013455 $11,324,171.85 5 $16,579,720 0.620921323 $10,294,701.68 6 $16,579,720 0.56447393 $9,358,819.71 7 $16,579,720 0.513158118 $8,508,017.92 Working Capital 7 $1,320,000 0.513158118 $677,368.72 Best Case NPV $51,234,389.56 Worst Case Sales New clubs = $738× 50400 $37,195,200 High-priced clubs = $1120 x -10670 -$11,950,400 Cheap clubs = $460 x 10080 $4,636,800 Total sales $29,881,600 Variable costs New clubs = $462 × 50400 $23,284,800 High-priced clubs = $720 x -10670 -$8,002,500 Cheap clubs = $240 x 10080 $2,570,400 Total Variable costs $17,852,700 Pro forma income statement Sales $29,881,600 Less: variable cost -17852700 Less: Fixed cost -$10,032,000 Less: Depreciation = $28,840,000/7 -$4,120,000 EBT -$2,123,100 Taxes @ 35% -$743,085 Net Income -$1,380,015 OCF = NI + Depreciation $2,739,985 Initial Investment $28,840,000 Add: working capital $1,320,000 Total cash flow in year 0 $30,160,000 NPV Year Cash flow PV @ 10% Present Value 0 -$30,160,000 1 -$30,160,000 1 $2,739,985 0.909090909 $2,490,895.45 2 $2,739,985 0.826446281 $2,264,450.41 3 $2,739,985 0.751314801 $2,058,591.28 4 $2,739,985 0.683013455 $1,871,446.62 5 $2,739,985 0.620921323 $1,701,315.11 6 $2,739,985 0.56447393 $1,546,650.1 7 $2,739,985 0.513158118 $1,406,045.55 Working Capital 7 $1,320,000 0.513158118 $677,368.72 Worst Case NPV -$16,143,236.75