McGilla Golf has decided to sell a new line of golf clubs and would like to know
ID: 2730031 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs and 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 $870 per set and have a variable cost of $470 per set. The company has spent $157,000 for a marketing study that determined the company will sell 61,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,200 sets of its high-priced clubs. The high-priced clubs sell at $1,170 and have variable costs of $770. The company will also increase sales of its cheap clubs by 11,700 sets. The cheap clubs sell for $510 and have variable costs of $265 per set. The fixed costs each year will be $9,170,000. The company has also spent $1,180,000 on research and development for the new clubs. The plant and equipment required will cost $29,190,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,370,000 that will be returned at the end of the project. The tax rate is 30 percent, and the cost of capital is 10 percent. What is the sensitivity of the NPV to each of these variables?Explanation / Answer
Answer:-
Finding NPV/P
The marketing study and the research and development are both sunk costs and should beignored. We will calculate the sales and variable costs first. Since we will lose sales of theexpensive clubs and gain sales of the cheap clubs, these must be accounted for as erosion.
Sales
New clubs 870 × 61,000 = 53,070,000
Exp. Clubs $1,170 × (–10,200) = –11,934,000
Cheap clubs $510 × 11,700 = 5,967,000
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47,103,000
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:
Var. Costs
New clubs –$470 × 61,000 = –28,670,000
Exp. Clubs –$770 × (–10,200) = 7,854,000
Cheap clubs –$265 × 11,700 = – 3,100,500
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-23,916,500
The pro forma income statement will be:
Sales $47,103,000
Variable Costs 23,916,500
Fixed Costs 9,170,000
Depreciation 4,170,000
EBIT 9,846,500= Sales – (Variable Costs + Fixed Costs) – Depreciation
Taxes (30%) 2,953,950= 0.30(EBIT)
Net Income 6,892,550= EBIT – Taxes
OCF = NI + Depreciation = $6,892,550 + 4,170,000 = 11,062,550
NPV = –$29,190,000 – 1,370,000 + 11,062,550(PVIFA10%,7) + $1,400,000/1.107NPV= 26,025,098