McGilla Golf has decided to sell a new line of golf clubs. The company would lik
ID: 2726542 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The company would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. 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. What is the sensitivity of the NPV to each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)
McGilla Golf has decided to sell a new line of golf clubs. The company would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. 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. What is the sensitivity of the NPV to each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)
NPVExplanation / Answer
Part 1)
We will have to calculate the cash flow per year in order to arrive at the NPV. The cash flows have been calculated with the use of following table:
NPV is the difference between the present value of cash inflows and cash outflows. The formula for calculating NPV is given below:
NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Cost of Capital)^1 + Cash Flow Year 2/(1+Cost of Capital)^2 + Cash Flow Year 3/(1+Cost of Capital)^3 + Cash Flow Year 4/(1+Cost of Capital)^4 + Cash Flow Year 5/(1+Cost of Capital)^5 + Cash Flow Year 6/(1+Cost of Capital)^6 + Cash Flow Year 7/(1+Cost of Capital)^7
Using the values calculated above, we get,
NPV = (-28,280,000 - 1,240,000) + 8,619,200/(1+10%)^1 + 8,619,200/(1+10%)^2 + 8,619,200/(1+10%)^3 + 8,619,200/(1+10%)^4 + 8,619,200/(1+10%)^5 + 8,619,200/(1+10%)^6 + 9,859,200/(1+10%)^7 = $13,078,191.54
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To determine price sensitivity, we need to calculate NPV at a revised price for New Clubs. Let us assume that the new price is $800.
The revised cash flows have been calculated as follows:
Revised NPV is calculated as follows:
Revised NPV = (-28,280,000 - 1,240,000) + 10,635,200/(1+10%)^1 + 10,635,200/(1+10%)^2 + 10,635,200/(1+10%)^3 + 10,635,200/(1+10%)^4 + 10,635,200/(1+10%)^5 + 10,635,200/(1+10%)^6 + 11,875,200/(1+10%)^7 = $22,892,923.88
Now, we can calculate the price sensitivity as follows:
Change in NPV/Change in Price (Price Sensitivity) = (22,892,923.88 - 13,078,191.54)/(800 - 740) = $163,578.87
The price sensitivity indicates that for every increase/decrease in dollar priice, the NPV increases/decreases by $163,578.87
__________
Part 2)
To determine quantity sensitivity, we need to calculate NPV at a revised quantity for New Clubs. Let us assume that the new quantity is 56,100.
The revised cash flows have been calculated as follows:
Revised NPV is calculated as follows:
Revised NPV = (-28,280,000 - 1,240,000) + 8,663,600/(1+10%)^1 + 8,663,600/(1+10%)^2 + 8,663,600/(1+10%)^3 + 8,663,600/(1+10%)^4 + 8,663,600/(1+10%)^5 + 8,663,600/(1+10%)^6 + 9,903,600/(1+10%)^7 = $13,294,349.34
Now, we can calculate the quantity sensitivity as follows:
Change in NPV/Change in Quantity (Quantity Sensitivity) = (13,294,349.34 - 13,078,191.54)/(56,100 - 56,000) = $2,161.58
The quantity sensitivity indicates that for every increase/decrease in quantity, the NPV increases/decreases by $2161.58
Cash Flow Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Sales New Sets (56,000*740) 41440000 41440000 41440000 41440000 41440000 41440000 41440000 High Priced Clubs (-8,900*1040) -9256000 -9256000 -9256000 -9256000 -9256000 -9256000 -9256000 Cheap Clubs (10,400*380) 3952000 3952000 3952000 3952000 3952000 3952000 3952000 Total Sales Value (A) 36136000 36136000 36136000 36136000 36136000 36136000 36136000 Less Variable Costs New Sets (56,000*340) 19040000 19040000 19040000 19040000 19040000 19040000 19040000 High Priced Clubs (-8,900*640) -5696000 -5696000 -5696000 -5696000 -5696000 -5696000 -5696000 Cheap Clubs (10,400*200) 2080000 2080000 2080000 2080000 2080000 2080000 2080000 Total Variable Costs (B) 15424000 15424000 15424000 15424000 15424000 15424000 15424000 Less Fixed Cost (C) 9040000 9040000 9040000 9040000 9040000 9040000 9040000 Less Depreciation (D) [28,280,000/7] 4040000 4040000 4040000 4040000 4040000 4040000 4040000 EBT (A-B-C-D) 7632000 7632000 7632000 7632000 7632000 7632000 7632000 Less Taxes 3052800 3052800 3052800 3052800 3052800 3052800 3052800 EAT 4579200 4579200 4579200 4579200 4579200 4579200 4579200 Add Depreciation 4040000 4040000 4040000 4040000 4040000 4040000 4040000 Operating Cash Flows 8619200 8619200 8619200 8619200 8619200 8619200 8619200 Add Recovery of Working Capital 0 0 0 0 0 0 1240000 Net Cash Flow $8619200 $8619200 $8619200 $8619200 $8619200 $8619200 $9859200