McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2641569 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $875 per set and have a variable cost of $430 per set. The company has spent $150,000 for a marketing study that determined the company will sell 60,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 12,000 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $620. The company will also increase sales of its cheap clubs by 15,000 sets. The cheap clubs sell for $400 and have variable costs of $210 per set. The fixed costs each year will be $9,300,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $29,400,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,400,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 14 percent. Calculate the payback period, the NPV, and the IRR.
Explanation / Answer
Solution is given assuming that increase in sales of cheap clubs and decrease in high priced clubs is directly relted to launch of new line of golf clubs.
Assuming that initial investment in plant and equiment is in year 0 and cash flows from year 1 to year 7, and working capital will be returned at the end of year7.
Payback period = Initial investment/cashflow after tax per year = 30,800,000/10,374,000= 2.97 years or say 3 years
NPV = 14,246,367
IRR = 27.89%
Computation of cashflow from operations each year Particulars Per unit No.of units Amount ($) Sale of new golf club i 875 60,000 5,25,00,000 Variable cost ii 430 60,000 2,58,00,000 Contribution from new golf club iii = i-ii 2,67,00,000 Fixed cost iv 93,00,000 Depreciation on new Plant and equipment v 42,00,000 Profit from new gof club vi=iii-iv-v 1,32,00,000 Loss of high piced clubs vii (1100-620) 12,000 57,60,000 Gain from increase in sale of cheap clubs viii (400-210) 15,000 28,50,000 Total Incremental Profit ix=vi-vii+viii 1,02,90,000 Tax @ 40% x=ix*40% 41,16,000 Profit after Tax per year xi=ix-x 61,74,000 Cash flow after tax xii=xi+v 1,03,74,000