McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2647632 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $731 per set and have a variable cost of $361 per set. The company has spent $151,000 for a marketing study that determined the company will sell 75,100 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,600 sets per year of its high-priced clubs. The high-priced clubs sell at $1,210 and have variable costs of $550. The company will also increase sales of its cheap clubs by 11,100 sets per year. The cheap clubs sell for $341 and have variable costs of $126 per set. The fixed costs each year will be $11,210,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $24,570,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,510,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 15 percent.
Calculate the payback period, the NPV, and the IRR.
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $731 per set and have a variable cost of $361 per set. The company has spent $151,000 for a marketing study that determined the company will sell 75,100 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,600 sets per year of its high-priced clubs. The high-priced clubs sell at $1,210 and have variable costs of $550. The company will also increase sales of its cheap clubs by 11,100 sets per year. The cheap clubs sell for $341 and have variable costs of $126 per set. The fixed costs each year will be $11,210,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $24,570,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,510,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 15 percent.
Explanation / Answer
1 Calculation of Payback Period Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Sales ($) 75100 Sets *$731 $ 54,898,100 $ 54,898,100 $ 54,898,100 $ 54,898,100 $ 54,898,100 $ 54,898,100 $ 54,898,100 Less:variable cost = 75100 Sets * $361 $ (27,111,100) $ (27,111,100) $ (27,111,100) $ (27,111,100) $ (27,111,100) $ (27,111,100) $ (27,111,100) Less: loss of contribution on high-priced clubs = 8600 Sets * ($1210-550) $ (5,676,000) $ (5,676,000) $ (5,676,000) $ (5,676,000) $ (5,676,000) $ (5,676,000) $ (5,676,000) Less: Fixed costs $ (11,210,000) $ (11,210,000) $ (11,210,000) $ (11,210,000) $ (11,210,000) $ (11,210,000) $ (11,210,000) Add: Additional contribution on cheap clubs 11100 sets * ($341-126) $ 2,386,500 $ 2,386,500 $ 2,386,500 $ 2,386,500 $ 2,386,500 $ 2,386,500 $ 2,386,500 Less: Depreciation on plant 24570000/7 $ (3,510,000) $ (3,510,000) $ (3,510,000) $ (3,510,000) $ (3,510,000) $ (3,510,000) $ (3,510,000) Income before tax $ 9,777,500 $ 9,777,500 $ 9,777,500 $ 9,777,500 $ 9,777,500 $ 9,777,500 $ 9,777,500 Less: tax = Income before tax *35% $ (3,422,125) $ (3,422,125) $ (3,422,125) $ (3,422,125) $ (3,422,125) $ (3,422,125) $ (3,422,125) Income after tax $ 6,355,375 $ 6,355,375 $ 6,355,375 $ 6,355,375 $ 6,355,375 $ 6,355,375 $ 6,355,375 Add: depreciation $ 3,510,000 $ 3,510,000 $ 3,510,000 $ 3,510,000 $ 3,510,000 $ 3,510,000 $ 3,510,000 Cash flows after tax $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 Cost of plant (Initial) $ (24,570,000) Investment in Net working capital $ (1,510,000) $ 1,510,000 Net cash flows $ (26,080,000) $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 11,375,375 Cummulative net cash flows $ (26,080,000) $ (16,214,625) $ (6,349,250) $ 3,516,125 $ 13,381,500 $ 23,246,875 $ 33,112,250 $ 44,487,625 we can see that Cummulative net cash flows becomes positive In the year 3 it means the payback period is in betrween 2 to 3 year so the exact payback period = 2 year + (1 year *6349250/9865375) = 2.64 Years 2 Calculation of NPV Net cash flows $ (26,080,000) $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 11,375,375 PVF (15%) 1.00000 0.86957 0.75614 0.65752 0.57175 0.49718 0.43233 0.37594 PV = Net cash flows * PVF $ (26,080,000.00) $ 8,578,586.96 $ 7,459,640.83 $ 6,486,644.20 $ 5,640,560.18 $ 4,904,834.93 $ 4,265,073.86 $ 4,276,424.81 NPV = Sum of PVs $ 15,531,765.76 3 Calculation of IRR Net cash flows $ (26,080,000) $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 9,865,375 $ 11,375,375 IRR 32.93% Using IRR formula = IRR ()