McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2489126 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $777 per set and have a variable cost of $384 per set. The company has spent $199456 for a marketing study that determined the company will sell 55506 sets per year for seven years. The marketing study also determined that the company will lose sales of 9281 sets of its high-priced clubs. The high-priced clubs sell at $1059 and have variable costs of $652. The company will also increase sales of its cheap clubs by 10086 sets. The cheap clubs sell for $469 and have variable costs of $225 per set. The fixed costs each year will be $9200875. The company has also spent $1126219 on research and development for the new clubs. The plant and equipment required will cost $28686583 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1251655 that will be returned at the end of the project. The tax rate is 31 percent, and the cost of capital is 8 percent.
What is the annual OCF for this project?
Hint: there are two sunk cost numbers in this question. Also, you want to consider the many spillover effects of the project.
Explanation / Answer
Solution :
sales from new line of golf club (=777*55506)
43,128,162
variable cost for new line (384*55506)
- 21,314,304
lost sales of 9281 sets of its high-priced clubs (=(1059-652)*9281)
- 3,777,367
increase sales of its cheap clubs by 10086 sets =(469-225)*10086
2,460,984
fixed cost
- 9,200,875
depreciation pa (28686583/7)
- 4,098,083
Profit before tax
7,198,517
tax 31%
- 2,231,540
profit after tax
4,966,977
add : depreciation being the non cash expense
4,098,083
annual operating cash flow
9,065,060
marketing study cost of 199456 & research and development cost of 1126219 has been ignored being the sunk cost.
sales from new line of golf club (=777*55506)
43,128,162
variable cost for new line (384*55506)
- 21,314,304
lost sales of 9281 sets of its high-priced clubs (=(1059-652)*9281)
- 3,777,367
increase sales of its cheap clubs by 10086 sets =(469-225)*10086
2,460,984
fixed cost
- 9,200,875
depreciation pa (28686583/7)
- 4,098,083
Profit before tax
7,198,517
tax 31%
- 2,231,540
profit after tax
4,966,977
add : depreciation being the non cash expense
4,098,083
annual operating cash flow
9,065,060