McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2631360 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $747 per set and have a variable cost of $377 per set. The company has spent $167,000 for a marketing study that determined the company will sell 76,700 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,200 sets per year of its high-priced clubs. The high-priced clubs sell at $1,370 and have variable costs of $710. The company will also increase sales of its cheap clubs by 12,700 sets per year. The cheap clubs sell for $357 and have variable costs of $142 per set. The fixed costs each year will be $11,370,000. The company has also spent $1,170,000 on research and development for the new clubs. The plant and equipment required will cost $25,690,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,670,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 16 percent.
Required: Calculate the payback period, the NPV, and the IRR. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Explanation / Answer
Contribution per set of new golf clubs = 747 - 377 = 370/set
Total contribution from new golf clubs = 370/set * 76,700 sets = 28,379,000
Contribution per set of high-priced golf clubs = 1370 - 710 = 660/set
Total contribution loss from high-priced golf clubs = 660/set * 10,200 = 6,732,000
Contribution per set of cheap golf clubs = 357 - 142 = 215/set
Total contribution from cheap golf clubs = 215/set * 12,700 = 2,730,500
So total contribution each year = 28,379,000 - 6,732,000 + 2,730,500 = 24,377,500
Fixed costs = 11,370,000
Annual depreciation = 25,690,000 / 7 = 3,670,000
So total profit = contribution - fixed cost - depreciation = 24,377,500 - 11,370,000 - 3,670,000 = 9,337,500
Net income = 9,337,500 * (1-tax rate) = 9,337,500 * (1-35%) = 6,069,375
Annual cashflow = net income + depreciation = 6,069,375 + 3,670,000 = 9,739,375
Year 0 cashflow = initial investment in capex and working capital = -25,690,000 - 1,670,000 = -27,360,000
Year 1-6 cashflow = 9,739,375
Year 7 cashflow = 9,739,375 + 1,670,000 = 11,409,375
So NPV = -27,360,000 + 9,739,375 / (1+16%)^1 + 9,739,375 / (1+16%)^2 + 9,739,375 / (1+16%)^3 + 9,739,375 / (1+16%)^4 + 9,739,375 / (1+16%)^5 + 9,739,375 / (1+16%)^6 + 11,409,375 / (1+16%)^7 = $ 12,563,998.58
Payback period = initial investment / yearly cashflow = 27,360,000 / 9,739,375 = 2.81 years
Let IRR be r%
So 27,360,000 = 9,739,375 / (1+r)^1 + 9,739,375 / (1+r)^2 + 9,739,375 / (1+r)^3 + 9,739,375 / (1+r)^4 + 9,739,375 / (1+r)^5 + 9,739,375 / (1+r)^6 + 11,409,375 / (1+r)^7
Solving for r in Excel, we get r = IRR = 30.31%
Answer: NPV = $ 12,563,998.58, Payback period = 2.81 years and IRR = 30.31%
Hope this helped ! Let me know in case of any queries.