McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2730342 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $720 per set and have a variable cost of $320 per set. The company has spent $142,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,700 sets of its high-priced clubs. The high-priced clubs sell at $1,020 and have variable costs of $620. The company will also increase sales of its cheap clubs by 10,200 sets. The cheap clubs sell for $360 and have variable costs of $190 per set. The fixed costs each year will be $9,020,000. The company has also spent $1,030,000 on research and development for the new clubs. The plant and equipment required will cost $28,140,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,220,000 that will be returned at the end of the project. The tax rate is 36 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.)
Explanation / Answer
Only sales of existing two sets assumed variable with +/- 10% rang, other factors assumed fixed as the question is not specific about any other factors. McGilla Golf club Sales Details Best Case New Sets High Price Cheap club Unit Selling Price 720 1,020 360 UnitVAriable cost 320 620 190 Unit Contribution margin 400 400 170 Units of sales/Loss/gain of sales 54,000 (7,830) 11,220 Yearly Contribution margin 21,600,000 (3,132,000) 1,907,400 Yearly Incremental Contribution 20,375,400 Worst case scenario Sales Details worst New Sets High Price Cheap club Unit Selling Price 720 1,020 360 UnitVAriable cost 320 620 190 Unit Contribution margin 400 400 170 Units of sales/Loss of sales 54,000 (9,570) 9,180 Yearly Contribution margin 21,600,000 (3,828,000) 1,560,600 Yearly Incremental Contribution 19,332,600 NPV Best Case Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Equipment Cost (28,140,000) NWC investment (1,220,000) 1,220,000 Yearly Incremental Contribution 20,375,400 20,375,400 20,375,400 20,375,400 20,375,400 20,375,400 20,375,400 Less Fixed cost (9,020,000) (9,020,000) (9,020,000) (9,020,000) (9,020,000) (9,020,000) (9,020,000) Less Depreciation (4,020,000) (4,020,000) (4,020,000) (4,020,000) (4,020,000) (4,020,000) (4,020,000) Taxable Income 7,335,400 7,335,400 7,335,400 7,335,400 7,335,400 7,335,400 7,335,400 Tax @36% 2,640,744 2,640,744 2,640,744 2,640,744 2,640,744 2,640,744 2,640,744 Post Tax Income 4,694,656 4,694,656 4,694,656 4,694,656 4,694,656 4,694,656 4,694,656 Add Back depreciation 4,020,000 4,020,000 4,020,000 4,020,000 4,020,000 4,020,000 4,020,000 Net Cash flow (29,360,000) 8,714,656 8,714,656 8,714,656 8,714,656 8,714,656 8,714,656 9,934,656 PV factor @10% 1 0.909 0.826 0.751 0.68 0.621 0.564 0.513 PV of Cash flows (29,360,000) 7,922,415 7,202,195 6,547,450 5,952,227.31 5,411,116 4,919,196 5,098,049 NPV = 13,692,648 NPV Worst Case Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Equipment Cost (28,140,000) NWC investment (1,220,000) 1,220,000 Yearly Incremental Contribution 19,332,600 19,332,600 19,332,600 19,332,600.00 19,332,600 19,332,600 19,332,600 Less Fixed cost (9,020,000) (9,020,000) (9,020,000) (9,020,000.00) (9,020,000) (9,020,000) (9,020,000) Less Depreciation (4,020,000) (4,020,000) (4,020,000) (4,020,000.00) (4,020,000) (4,020,000) (4,020,000) Taxable Income 6,292,600 6,292,600 6,292,600 6,292,600.00 6,292,600 6,292,600 6,292,600 Tax @36% 2,265,336 2,265,336 2,265,336 2,265,336 2,265,336 2,265,336 2,265,336 Post Tax Income 4,027,264 4,027,264 4,027,264 4,027,264.00 4,027,264 4,027,264 4,027,264 Add Back depreciation 4,020,000 4,020,000 4,020,000 4,020,000.00 4,020,000 4,020,000 4,020,000 Net Cash flow (29,360,000) 8,047,264 8,047,264 8,047,264 8,047,264.00 8,047,264 8,047,264 9,267,264 PV factor @10% 1 0.909 0.826 0.751 0.68 0.621 0.564 0.513 PV of Cash flows (29,360,000) 7,315,695 6,650,631 6,046,029 5,496,389.59 4,996,718 4,542,471 4,755,572 NPV = 10,443,504 Best Case Worst Case So NPV details Are 13,692,648 10,443,504