McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2726538 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $800 per set and have a variable cost of $400 per set. The company has spent $150,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,500 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $700. The company will also increase sales of its cheap clubs by 11,000 sets. The cheap clubs sell for $440 and have variable costs of $230 per set. The fixed costs each year will be $9,100,000. The company has also spent $1,110,000 on research and development for the new clubs. The plant and equipment required will cost $28,700,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,300,000 that will be returned at the end of the project. The tax rate is 32 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.)
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $800 per set and have a variable cost of $400 per set. The company has spent $150,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,500 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $700. The company will also increase sales of its cheap clubs by 11,000 sets. The cheap clubs sell for $440 and have variable costs of $230 per set. The fixed costs each year will be $9,100,000. The company has also spent $1,110,000 on research and development for the new clubs. The plant and equipment required will cost $28,700,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,300,000 that will be returned at the end of the project. The tax rate is 32 percent, and the cost of capital is 10 percent.
NPV Best-case Worst-caseExplanation / Answer
Answer: The best case and worst cases for the variables are:
Best Case:
We will calculate the sales and variable costs first. Since we will lose sales of the expensive clubs and gain sales of the cheap clubs, these must be accounted for as erosion. The total sales for thenew project will be:
For the variable costs, we must include the units gained or lost from the existing clubs. Note thatthe 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:
The pro forma income statement will be:
NPV = –$28,700,000 – 1,300,000 + $16,148,920(PVIFA10%,7) + 1,300,000/1.107
NPV=-300,00,000+78619402.13+667105.55
=49286507.68
Worst case:
NPV = –$28,700,000 – 1,300,000 + $2329960(PVIFA10%,7) + 1,300,000/1.107
NPV=-300,00,000+11343177.26+667105.55
=-17989717.186
Particulars Base case Best case Worst case Unit sales (New) 54000 59400 48600 Price (New) 800 880 720 Variable cost (new) 400 360 440 Fixed costs 9100000 8190000 10010000 Sales lost (expensive) 9500 8550 10450 Sales gained (cheap) 11000 12100 9900