McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2631365 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $749 per set and have a variable cost of $379 per set. The company has spent $169,000 for a marketing study that determined the company will sell 76,900 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,400 sets per year of its high-priced clubs. The high-priced clubs sell at $1,390 and have variable costs of $730. The company will also increase sales of its cheap clubs by 12,900 sets per year. The cheap clubs sell for $359 and have variable costs of $144 per set. The fixed costs each year will be $11,390,000. The company has also spent $1,190,000 on research and development for the new clubs. The plant and equipment required will cost $25,830,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,690,000 that will be returned at the end of the project. The tax rate is 30 percent, and the cost of capital is 12 percent.
Explanation / Answer
Contribution per set of new golf clubs = 749 - 379 = 370/set
Total contribution from new golf clubs = 370/set * 76,900 sets = 28,453,000
Contribution per set of high-priced golf clubs = 1390 - 730 = 660/set
Total contribution loss from high-priced golf clubs = 660/set * 10,400 = 6,864,000
Contribution per set of cheap golf clubs = 359 - 144 = 215/set
Total contribution from cheap golf clubs = 215/set * 12,900 = 2,773,500
So total contribution each year = 28,453,000 - 6,864,000 + 2,773,500 = 24,362,500
Fixed costs = 11,390,000
Annual depreciation = 25,830,000 / 7 = 3,690,000
So total profit = contribution - fixed cost - depreciation = 24,362,500 - 11,390,000 - 3,690,000 = 9,282,500
Net income = 9,282,500 * (1-tax rate) = 9,282,500 * (1-30%) = 6,497,750
Annual cashflow = net income + depreciation = 6,497,750 + 3,690,000 = 10,187,750
Year 0 cashflow = initial investment in capex and working capital = -25,830,000 - 1,690,000 = -27,520,000
Year 1-6 cashflow = 10,187,750
Year 7 cashflow = 10,187,750 + 1,690,000 = 11,877,750
So NPV = -27,520,000 + 10,187,750 / (1+12%)^1 + 10,187,750 / (1+12%)^2 + 10,187,750 / (1+12%)^3 + 10,187,750 / (1+12%)^4 + 10,187,750 / (1+12%)^5 + 10,187,750 / (1+12%)^6 + 11,877,750 / (1+12%)^7 = 19,738,881
Payback period = initial investment / yearly cashflow = 27,520,000 / 10,187,750 = 2.70 years
Let IRR be r%
So 27,520,000 = 10,187,750 / (1+r)^1 + 10,187,750 / (1+r)^2 + 10,187,750 / (1+r)^3 + 10,187,750 / (1+r)^4 + 10,187,750 / (1+r)^5 + 10,187,750 / (1+r)^6 + 11,877,750 / (1+r)^7
Solving for r in Excel, we get r = IRR = 32%
Answer: NPV = $19,738,881, Payback period = 2.7 years and IRR = 32%
Hope this helped ! Let me know in case of any queries.