McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2711203 • 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 $340 per set. The company has spent $144,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,900 sets of its high-priced clubs. The high-priced clubs sell at $1,040 and have variable costs of $640. The company will also increase sales of its cheap clubs by 10,400 sets. The cheap clubs sell for $380 and have variable costs of $200 per set. The fixed costs each year will be $9,040,000. The company has also spent $1,050,000 on research and development for the new clubs. The plant and equipment required will cost $28,280,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,240,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent.
Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained or lost are uncertain.) (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained or lost are uncertain.) (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
1. Increase in Contribution:
Addl contribution on New line of golf clubs = 56000 * (740-340) = $ 22,400,000 (+)
Contribution lost on High price clubs = 8900 * (1040-640) = 3,560,000 (-)
Addl contribution on Cheap clubs = 10400 * (380-200) = 1,872,000 (+)
Net Increase in Contribution = $ 20,712,000
2) Yearly Cash flow (years 1 to 7) :
Best Case (+10%) Worst Case (-10%)
Increase in Contribution 22,783,200 18,640,800
Less Depreciation (28,280,000/7) 4,040,000 4,040,000
Less R&D and Market Study Exps (1,194,000/7) 170,571 170,571
Addl Profit before tax 18,572,629 14,430,229
Tax @ 40% 7,429,052 5,772,092
Profit after Tax 11,143,577 8,658,137
Add Depn & Amortisations 4,210,571 4,210,571
Addl Cash Flow (Annually for 7 years) 15,354,148 12,868,708
3) Initial Outlay incl Net Working Capital, R& D
and Market study exps 30,714,000 30,714,000
4) Residual Cash flow at the end of the 7th yr 0 0
5) PV of Annual cash flows at 10% discount Rate
(Yearly Cash Flows * PVIFA 10,7) 4.868 74,743,992 62,644,870
6) NPV = Value at (5) - Value at (3) 44,029,992 31,930,870
(Best Case) (Worst Case)