McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2634154 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $735 per set and have a variable cost of $365 per set. The company has spent $155,000 for a marketing study that determined the company will sell 75,500 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,000 sets per year of its high-priced clubs. The high-priced clubs sell at $1,250 and have variable costs of $590. The company will also increase sales of its cheap clubs by 11,500 sets per year. The cheap clubs sell for $345 and have variable costs of $130 per set. The fixed costs each year will be $11,250,000. The company has also spent $1,050,000 on research and development for the new clubs. The plant and equipment required will cost $24,850,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,550,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 14 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).) Payback period years Net present value $ Internal rate of return %
Explanation / Answer
Contribution per set of new golf clubs = 735 - 365 = 370/set
Total contribution from new golf clubs = 370/set * 75,500 sets = 27,935,000
Contribution per set of high-priced golf clubs = 1250 - 590 = 660/set
Total contribution loss from high-priced golf clubs = 660/set * 9,000 = 5,940,000
Contribution per set of cheap golf clubs = 345 - 130 = 215/set
Total contribution from cheap golf clubs = 215/set * 11,500 = 2,472,500
So total contribution each year = 27,935,000 - 5,940,000 + 2,472,500 = 24,467,500
Fixed costs = 11,250,000
Annual depreciation = 24,850,000 / 7 = 3,550,000
So total profit = contribution - fixed cost - depreciation = 24,467,500 - 11,250,000 - 3,550,000 = 9,667,500
Net income = 9,667,500 * (1-tax rate) = 9,667,500 * (1-40%) = 5,800,500
Annual cashflow = net income + depreciation = 5,800,500 + 3,550,000 = 9,350,500
Year 0 cashflow = initial investment in capex and working capital = -24,850,000 - 1,550,000 = -26,400,000
Year 1-6 cashflow = 9,350,500
Year 7 cashflow = 9,350,500 + 1,550,000 = 10,900,500
So NPV = -26,400,000 + 9,350,500 / (1+14%)^1 + 9,350,500 / (1+14%)^2 + 9,350,500 / (1+14%)^3 + 9,350,500 / (1+14%)^4 + 9,350,500 / (1+14%)^5 + 9,350,500 / (1+14%)^6 + 10,900,500 / (1+14%)^7 =14,317,232.25
Payback period = initial investment / yearly cashflow = 26,400,000 / 9,350,500 = 2.82 years
Let IRR be r%
So 26,400,000 = 9,350,500 / (1+r)^1 + 9,350,500 / (1+r)^2 + 9,350,500 / (1+r)^3 + 9,350,500 / (1+r)^4 + 9,350,500 / (1+r)^5 + 9,350,500 / (1+r)^6 + 10,900,500 / (1+r)^7
Solving for r by trial and error, we get r = IRR = 30.08%
Answer: NPV = $ 14,317,232.25, Payback period = 2.82 years and IRR = 30.08%
Hope this helped ! Let me know in case of any queries.