McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2649628 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $738 per set and have a variable cost of $368 per set. The company has spent $158,000 for a marketing study that determined the company will sell 75,800 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,300 sets per year of its high-priced clubs. The high-priced clubs sell at $1,280 and have variable costs of $620. The company will also increase sales of its cheap clubs by 11,800 sets per year. The cheap clubs sell for $348 and have variable costs of $133 per set. The fixed costs each year will be $11,280,000. The company has also spent $1,080,000 on research and development for the new clubs. The plant and equipment required will cost $25,060,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,580,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 13 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 $738 per set and have a variable cost of $368 per set. The company has spent $158,000 for a marketing study that determined the company will sell 75,800 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,300 sets per year of its high-priced clubs. The high-priced clubs sell at $1,280 and have variable costs of $620. The company will also increase sales of its cheap clubs by 11,800 sets per year. The cheap clubs sell for $348 and have variable costs of $133 per set. The fixed costs each year will be $11,280,000. The company has also spent $1,080,000 on research and development for the new clubs. The plant and equipment required will cost $25,060,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,580,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 13 percent.
Explanation / Answer
Calculation of Net Inflow Per Year:
Revenue from New Line of Golf Clubs:
Selling Price per Set = $738
Less: Variable Cost= $368
Contribution per Set = $370
Total Contribution on New Line of Golf Set = 75,800 x 370 = $28,046,000
Contribution of Cheap Club = 348 - 133 = $215
Total Contribution = 215 x 11,800 = $2,537,000
Loss of Contribution on High Priced Clubs:
Contribution on High Priced Clubs = 1,280 - 620 = $660
Total Loss of Contribution = 660 x 9,300 = $6,138,000
Net Increase in Contribution: 28,046,000 + 2,537,000 - 6,138,000 = $24,445,000
Net Inflow per Year = Contribution - Fixed Cost
Net Inflow per Year = 24,445,000 - 11,280,000 = $13,165,000
Less: Depreciation = $3,580,000 per Year
Earning Before Tax = 13,165,000 - 3,580,000 = $9,585,000
Less: Tax (40%) 9,585,000 x 40% = $3,834,000
Earning After Tax = 9,585,000 - 3,834,000 = $5,751,000
Add: Depreciation = 5,751,000 + 3,580,000 = $9,331,000
Calculation of Payback Period:
Initial Investment = Plant and Equipment = $25,060,000
Add: Investment in Additional Working Capital = $1,580,000
Total $26,640,000
Payback Period = 2 + 7,978,000 / 9,331,000 = 2.85 Years
Calculation of NPV:
PV of 7 Years Annuity at 13% : C x [ 1 - (1+i) -n / i ]
C = Cash Flow per Period = $9,331,000
i = Discount Rate = 13%
n = Time = 7 Years
PV = 9,331,000 x [1 - (1 + 0.13) -7 / 0.13]
PV = $41,267,377.95
Present Value of Working Capital released after 7 years = $1,580,000 / (1+ 0.13)7
Present Value of Working Capital = $671,595.817
Total Present Value of Inflow = 41,267,377.95 + 671,595.817 = $41,938,973.76
Net Present Value = PV of Inflow - Outflow
NPV = 41,938,973.76 - 26,640,000 = 15,298,973.77
NPV = $15,298,973.77
Calculation of IRR:
NPV at 13% = 15,298,973.77
Now we Calculate NPV at 35%:
PV of 7 Years Annuity at 35% : C x [ 1 - (1+i) -n / i ]
C = Cash Flow per Period = $9,331,000
i = Discount Rate = 35%
n = Time = 7 Years
PV = 9,331,000 x [1 - (1 + 0.35) -7 / 0.35]
PV = $23,397,700.98
Present Value of Working Capital released after 7 years = $1,580,000 / (1+ 0.35)7
Present Value of Working Capital = $193,339.55
Total Present Value of Inflow = 23,397,700.98 + 193,339.55 = $23,591,040.53
Net Present Value = PV of Inflow - Outflow
NPV = 23,591,040.53 - 26,640,000 = -$3,048,959.47
NPV = -$3,048,959.47
It means IRR is between 13% and 35%:
By interpolation:
IRR = Lowest Discount Rate + [ NPV at Lower Rate x (Higher Rate - Lower Rate) / (NPV at Lower Rate - NPV at Higher Rate)]
IRR = 0.13 + [ 15,298,973.77 x (0.35 - 0.13) / (15,298,973.77 - {-3,048,959.47})]
IRR = 31.34%
Year Inflow/ Outflow Cumulative Inflow ($) 0 -26,640,000 -26,640,000 1 9,331,000 -17,309,000 2 9,331,000 -7,978,000 3 9,331,000 1,353,000