McGilla Golf has decided to sell a new line of golf clubs. The company would lik
ID: 2727999 • 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 $810 per set and have a variable cost of $410 per set. The company has spent $151,000 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 9,600 sets of its high-priced clubs. The high-priced clubs sell at $1,110 and have variable costs of $710. The company will also increase sales of its cheap clubs by 11,100 sets. The cheap clubs sell for $450 and have variable costs of $235 per set. The fixed costs each year will be $9,110,000. The company has also spent $1,120,000 on research and development for the new clubs. The plant and equipment required will cost $28,770,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,310,000 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.) NPV
NPV/P $
NPV/Q $
Explanation / Answer
Solution.
Initial cost =$28,770,000 + 1,310,000
Initial cost = $30,080,000.
Calculation of the sales and variable costs.
Sales New clubs $810 × 55,000 = $44,550,000
Exp. clubs $1,110 × (–9,600) = –-10,656,000
Cheap clubs $450 × 11,100 = $4,995,000
Total = $38,889,000
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 $410 × 55,000 = $22,550,000
Exp. clubs $710 × (–9,600) = –-6,816,000
Cheap clubs $235 × 11,100 = $2,608,500
Total = $18,342,500.
The pro forma income statement will be:
Sales $38,889,000
Variable costs $18,342,500
Costs $9,110,000
Deprecia tion $4,110,000
EBIT $7,326,500
Taxes $2,930,600
Net income $4,395,900
Using the bottom up OCF calculation,
we get: OCF = NI + Depreciation
OCF = $4,395,900 + $4,110,000
OCF = $8,505,900
The NPV is:
Year Cashh inflow Table value P.V 0 (30,080,000.00) 1.0000 (30,080,000.00) 1 8,505,900.00 0.9090 7,731,863.10 2 8,505,900.00 0.8260 7,025,873.40 3 8,505,900.00 0.7510 6,387,930.90 4 8,505,900.00 0.6830 5,809,529.70 5 8,505,900.00 0.6209 5,281,313.31 6 8,505,900.00 0.5644 4,800,729.96 7 8,505,900.00 0.5131 4,364,377.29 7 1,310,000.00 0.5131 672,161.00 NPV 11,993,778.66