McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2726841 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $820 per set and have a variable cost of $420 per set. The company has spent $152,000 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 9,700 sets of its high-priced clubs. The high-priced clubs sell at $1,120 and have variable costs of $720. The company will also increase sales of its cheap clubs by 11,200 sets. The cheap clubs sell for $460 and have variable costs of $240 per set. The fixed costs each year will be $9,120,000. The company has also spent $1,130,000 on research and development for the new clubs. The plant and equipment required will cost $28,840,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,320,000 that will be returned at the end of the project. The tax rate is 35 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.) NPV Best-case $ Worst-case $
Explanation / Answer
McGilla Golf club Sales Details Best Case New Sets High Price Cheap club Unit Selling Price 820 1,120 460 UnitVAriable cost 420 720 240 Unit Contribution margin 400 400 220 Units of sales/Loss of sales 61,600 (8,730) 12,320 Yearly Contribution margin 24,640,000 (3,492,000) 2,710,400 Yearly Incremental Contribution 23,858,400 Worst case scenario Sales Details worst New Sets High Price Cheap club Unit Selling Price 820 1,120 460 UnitVAriable cost 420 720 240 Unit Contribution margin 400 400 220 Units of sales/Loss of sales 50,400 (10,670) 10,080 Yearly Contribution margin 20,160,000 (4,268,000) 2,217,600 Yearly Incremental Contribution 18,109,600 NPV Best Case Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Equipment Cost (28,840,000) NWC investment (1,320,000) 1,320,000 Yearly Incremental Contribution 23,858,400 23,858,400 23,858,400 23,858,400 23,858,400 23,858,400 23,858,400 Less Fixed cost (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) Less Depreciation (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) Taxable Income 10,618,400 10,618,400 10,618,400 10,618,400 10,618,400 10,618,400 10,618,400 Tax @35% 3,716,440 3,716,440 3,716,440 3,716,440 3,716,440 3,716,440 3,716,440 Post Tax Income 6,901,960 6,901,960 6,901,960 6,901,960 6,901,960 6,901,960 6,901,960 Add Back depreciation 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 Net Cash flow (30,160,000) 11,021,960 11,021,960 11,021,960 11,021,960 11,021,960 11,021,960 12,341,960 PV factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 PV of Cash flows (30,160,000) 10,019,964 9,109,058 8,280,962 7,528,147 6,843,770 6,221,609 6,333,377 NPV = 24,176,886 NPV Worst Case Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Equipment Cost (28,840,000) NWC investment (1,320,000) 1,320,000 Yearly Incremental Contribution 18,109,600 18,109,600 18,109,600 18,109,600 18,109,600 18,109,600 18,109,600 Less Fixed cost (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) (9,120,000) Less Depreciation (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) (4,120,000) Taxable Income 4,869,600 4,869,600 4,869,600 4,869,600 4,869,600 4,869,600 4,869,600 Tax @35% 1,704,360 1,704,360 1,704,360 1,704,360 1,704,360 1,704,360 1,704,360 Post Tax Income 3,165,240 3,165,240 3,165,240 3,165,240 3,165,240 3,165,240 3,165,240 Add Back depreciation 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 4,120,000 Net Cash flow (30,160,000) 7,285,240 7,285,240 7,285,240 7,285,240 7,285,240 7,285,240 8,605,240 PV factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 PV of Cash flows (30,160,000) 6,622,945 6,020,860 5,473,509 4,975,917 4,523,561 4,112,328 4,415,849 NPV = 5,984,968 Best Case Worst Case So NPV details Are 24,176,886 5,984,968