McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2644977 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $740 per set and have a variable cost of $370 per set. The company has spent $160,000 for a marketing study that determined the company will sell 76,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,500 sets per year of its high-priced clubs. The high-priced clubs sell at $1,300 and have variable costs of $640. The company will also increase sales of its cheap clubs by 12,000 sets per year. The cheap clubs sell for $350 and have variable costs of $135 per set. The fixed costs each year will be $11,300,000. The company has also spent $1,100,000 on research and development for the new clubs. The plant and equipment required will cost $25,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,600,000 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. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $740 per set and have a variable cost of $370 per set. The company has spent $160,000 for a marketing study that determined the company will sell 76,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,500 sets per year of its high-priced clubs. The high-priced clubs sell at $1,300 and have variable costs of $640. The company will also increase sales of its cheap clubs by 12,000 sets per year. The cheap clubs sell for $350 and have variable costs of $135 per set. The fixed costs each year will be $11,300,000. The company has also spent $1,100,000 on research and development for the new clubs. The plant and equipment required will cost $25,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,600,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 14 percent.
Explanation / Answer
Selling price - variable cost of new line of golf clubs = $740-$370 per set = $370 per set.
expected number of sets to be sold per year = 76,000. Total income = $370*76,000 = $28,120,000 per year.
Intitial cash outflow on marketing = - $160,000.
Selling price - variable cost of high priced line of golf clubs = 1,300 - 640 = $660 per set. Loss of sales = 9,500 sets per year. Loss of income = $660*9500 = 6,270,000. This is a loss of income per year.
Selling price - variable cost of cheap golf clubs = 350-135 = $215 per set. Gain in sales = 12,000 sets per year. Gain of income = 12,000*$215 = $2,580,000
Net effect of income from new line, decrease in sales of expensive lines, increase in sales of cheap line = $28,120,000 - $6,270,000 + $2,580,000 = $24,430,000 per year.
Depreciation on plant and equipment = $25,200,000/7 = $3,600,000 per year. Tax shield on depreciation = depreciation*tax rate = $3,600,000*40% = $1,440,000.
Cost of capital = 14%, so discount factor will be 1+14% = 1.14. PV formula = amount of cash flow/(discount factor)^(time in years)
Operating cash flow = Net effect of income from new line, decrease in sales of expensive lines, increase in sales of cheap line+depreciation tax shield-fixed costs = $24,430,000+1,440,000-11,300,000 = $14,570,000
(i) payback period = length of time required to recover the initial cash outflow:
As we can see, the cumulative cash flow is become positive in the 2nd year, so the payback occurs after the end of 1st year. Payback = 1+[(13,490,000/13,490,000+1,080,000)] = 1+0.93 = 1.93 years
(ii) NPV: PV formula = cash flow/(disccount factor)^time. Discount factor = 1+cost of capital = 1+14% = 1.14
(iii) IRR is the rate which makes the NPV as 0. Using trial and error method and changing the cost of capital till we get NPV as 0, the rate is 48.895999%
Year Cash flow Description Cumulative cash flow 0 -160,000 Cash outflow on marketing study -160,000.00 0 -1,100,000 Research and development cost -1,260,000.00 0 -25,200,000 Plant and equipment -26,460,000.00 0 -1,600,000 Increase in working capital -28,060,000.00 1 14,570,000 Operating cash flow -13,490,000.00 2 14,570,000 Operating cash flow 1,080,000.00 3 14,570,000 Operating cash flow 4 14,570,000 Operating cash flow 5 14,570,000 Operating cash flow 6 14,570,000 Operating cash flow 7 14,570,000 Operating cash flow 7 1,600,000 Return of working capital