McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2726982 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $900 per set and have a variable cost of $500 per set. The company has spent $159,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 11,000 sets of its high-priced clubs. The high-priced clubs sell at $1,190 and have variable costs of $790. The company will also increase sales of its cheap clubs by 11,500 sets. The cheap clubs sell for $530 and have variable costs of $275 per set. The fixed costs each year will be $9,190,000. The company has also spent $1,200,000 on research and development for the new clubs. The plant and equipment required will cost $29,330,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,390,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 12 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
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 = –$29,330,000 – 1,390,000 + $15,874,850(PVIFA12%,7) + 1,390,000/1.127
NPV=42357715.90
Worst case:
Particulars Base case Best case Worst case Unit sales (new) 55000 60500 49500 Price (New) 900 990 810 Variable costs (New) 500 450 550 Fixed costs 9190000 8271000 10109000 Sales lost (expensive) 11000 9900 12100 Sales gained (cheap) 11500 12650 10350