McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2726883 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $700 per set and have a variable cost of $300 per set. The company has spent $140,000 for a marketing study that determined the company will sell 52,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets of its high-priced clubs. The high-priced clubs sell at $1,000 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $340 and have variable costs of $180 per set. The fixed costs each year will be $9,000,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $28,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,200,000 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.)
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $700 per set and have a variable cost of $300 per set. The company has spent $140,000 for a marketing study that determined the company will sell 52,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets of its high-priced clubs. The high-priced clubs sell at $1,000 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $340 and have variable costs of $180 per set. The fixed costs each year will be $9,000,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $28,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,200,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 10 percent.
Explanation / Answer
Solution.
Initial cost =$28,000,000 + 1,200,000
Initial cost = $29,200,000.
Calculation of the sales and variable costs.
Sales New clubs $700 × 52,000 = $36,400,000
Exp. clubs $1,000 × (–8,500) = –-8,500,000
Cheap clubs $340 × 10,000 = $3,400,000
Total = $31,300,000
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:
Var. costs
Sales New clubs $300 × 52,000 = $15,600,000
Exp. clubs $600 × (–8,500) = –-5,100,000
Cheap clubs $180 × 10,000 = $1,800,000
Total = $12,300,000.
The pro forma income statement will be:
Sales $31,300,000
Variable costs $12,300,000
Costs $9,000,000
Deprecia tion 4,000,000
EBIT 6,000,000
Taxes 2,100,000
Net income $3,900,000
Using the bottom up OCF calculation,
we get: OCF = NI + Depreciation
OCF = $3,900,000 +4,000,000
OCF = $7,900,000
The NPV is:
Year Cash Flow Table value P.V 0 (29,200,000) 1.0000 (29,200,000) 1 79,000,000 0.8690 68,651,000 2 79,000,000 0.7560 59,724,000 3 79,000,000 0.6570 51,903,000 4 79,000,000 0.5710 45,109,000 5 79,000,000 0.4970 39,263,000 6 79,000,000 0.4320 34,128,000 7 79,000,000 0.3750 29,625,000 7 1,200,000 0.3750 450,000 NPV 299,653,000.00