McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2649157 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $737 per set and have a variable cost of $367 per set. The company has spent $157,000 for a marketing study that determined the company will sell 75,700 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,200 sets per year of its high-priced clubs. The high-priced clubs sell at $1,270 and have variable costs of $610. The company will also increase sales of its cheap clubs by 11,700 sets per year. The cheap clubs sell for $347 and have variable costs of $132 per set. The fixed costs each year will be $11,270,000. The company has also spent $1,070,000 on research and development for the new clubs. The plant and equipment required will cost $24,990,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,570,000 that will be returned at the end of the project. The tax rate is 30 percent, and the cost of capital is 16 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).)
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).)
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Part A:
Annual Incremental Cash Flow = [75700*(737-367) - 9200*(1270 - 610) + 11700*(347 - 132) - 11270000 - 24990000/7]*(1-.30) + 24990000/7 = 10298750
Net Working Capital Required = 1570000
NPV = -24990000 - 1570000 + 10298750/(1+16%)^1 + 10298750/(1+16%)^2 + 10298750/(1+16%)^3 + 10298750/(1+16%)^4 + 10298750/(1+16%)^5 + 10298750/(1+16%)^6 + 10298750/(1+16%)^7 + 1570000/(1+16%)^7 = $15587688.17
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Part B:
To calculate IRR, you need to put the value of NPV as 0 and solve for R as follows:
NPV = 0 = -24990000 - 1570000 + 10298750/(1+r)^1 + 10298750/(1+r)^2 + 10298750/(1+r)^3 + 10298750/(1+r)^4 + 10298750/(1+r)^5 + 10298750/(1+r)^6 + 10298750/(1+r)^7 + 1570000/(1+r)^7
Solving for r, we get IRR as 34.05%
IRR = 34.05%
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Part C:
The Initial Investment will be recovered as follows:
Year 1 = 10298750
Year 2 = 10298750
and the balance between Year 2 and Year 3
Payback Period = 2+(24990000 +1570000 - 2*10298750)/10298750 = 2.58 Years
Thanks.