McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2726738 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $750 per set and have a variable cost of $350 per set. The company has spent $145,000 for a marketing study that determined the company will sell 57,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,000 sets of its high-priced clubs. The high-priced clubs sell at $1,050 and have variable costs of $650. The company will also increase sales of its cheap clubs by 10,500 sets. The cheap clubs sell for $390 and have variable costs of $205 per set. The fixed costs each year will be $9,050,000. The company has also spent $1,060,000 on research and development for the new clubs. The plant and equipment required will cost $28,350,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,250,000 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 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 $750 per set and have a variable cost of $350 per set. The company has spent $145,000 for a marketing study that determined the company will sell 57,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,000 sets of its high-priced clubs. The high-priced clubs sell at $1,050 and have variable costs of $650. The company will also increase sales of its cheap clubs by 10,500 sets. The cheap clubs sell for $390 and have variable costs of $205 per set. The fixed costs each year will be $9,050,000. The company has also spent $1,060,000 on research and development for the new clubs. The plant and equipment required will cost $28,350,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,250,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent.
Explanation / Answer
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 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
The Proforma Income Statement will be
NPV = -$28350,000-$1250,000+$12,623,850 (PVIFA 10%, 7 years) +$1250,000(PVIF 10%, 7)
=$32,499,637
Worst Case
The Proforma Income Statement will be
NPV = -$28350,000-$1250,000+$5400,750(PVIFA 10%, 7 years) +$1250,000(PVIF 10%, 7)
= ($2,665,439)
Base Case Best Case Worst Case Unit Sales New 57000 62700 51300 Price New 750 825 675 Variable Cost New 350 385 315 Fixed Costs 9,050,000 8145000 9955000 Sale Lost Expensive 9000 8100 9900 Sale gained Cheap 10500 11550 9450