McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2725311 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $748 per set and have a variable cost of $378 per set. The company has spent $168,000 for a marketing study that determined the company will sell 76,800 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,300 sets per year of its high-priced clubs. The high-priced clubs sell at $1,380 and have variable costs of $720. The company will also increase sales of its cheap clubs by 12,800 sets per year. The cheap clubs sell for $358 and have variable costs of $143 per set. The fixed costs each year will be $11,380,000. The company has also spent $1,180,000 on research and development for the new clubs. The plant and equipment required will cost $25,760,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,680,000 that will be returned at the end of the project. The tax rate is 34 percent, and the cost of capital is 13 percent. 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
Solution:
Calculation of Payback Period, the NPV, and the IRR:
The marketing study and the research and development are both sunk costs and should be ignored.
The initial cost is the equipment plus the net working capital, so:
Initial cost = 25,760,000 + 1,680,000
Initial cost = 27,440,000
The total sales for the new project will be:
For the variable costs, we must include the units gained or lost from the existing clubs. Note that the variable costs of the expensive clubs are an inflow. If we are not producing the sets anymore, we will save these variable costs, which is an inflow. So:
Using the bottom up OCF calculation, we get:
OCF = NI + Depreciation
= 13,655,400 + 3,680,000
= 17,335,400
So, the payback period is:
Payback period = 1 + (10,104,600/ 17,335,400)
= 1 + 0.58
= 1.58 Years
The NPV is:
NPV = – 27,440,000 + 17,335,400 (PVIFA13%,7) + 1,680,000/1.137
NPV = – 27,440,000 + 17,335,400 (4.4226) + 1,680,000/2.35261
= – 27,440,000 + 76,667,540 + 714,101
= 49,941,641
And the IRR is:
0 = – 27,440,000 + 17,335,400 (PVIFA IRR%,7) + 1,680,000/IRR7
IRR = 61.06%
Sales New clubs (748 * 76,800) 57,446,400 Expensive clubs(1,380 * (-10,300)) (14,214,000) Cheap clubs (358 * 12,800) 4,582,400 47,814,800