McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2748704 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $760 per set and have a variable cost of $320 per set. The company has spent $126,000 for a marketing study that determined the company will sell 24,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 5,000 sets of its high-priced clubs. The high-priced clubs sell at $1,220 and have variable costs of $620. The company will also increase sales of its cheap clubs by 4,000 sets. The cheap clubs sell for $420 and have variable costs of $150 per set. The fixed costs each year will be $8,400,000. The company has also spent $1,176,000 on research and development for the new clubs. The plant and equipment required will cost $24,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,105,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 9 percent.
Suppose you feel that the values are accurate to within only ±6 percent. The best-case NPV is ____________ $ and worst-case NPV is __________________ $. (Do not include the dollar signs ($). Negative amount should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) (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.)
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $760 per set and have a variable cost of $320 per set. The company has spent $126,000 for a marketing study that determined the company will sell 24,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 5,000 sets of its high-priced clubs. The high-priced clubs sell at $1,220 and have variable costs of $620. The company will also increase sales of its cheap clubs by 4,000 sets. The cheap clubs sell for $420 and have variable costs of $150 per set. The fixed costs each year will be $8,400,000. The company has also spent $1,176,000 on research and development for the new clubs. The plant and equipment required will cost $24,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,105,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 9 percent.
Suppose you feel that the values are accurate to within only ±6 percent. The best-case NPV is ____________ $ and worst-case NPV is __________________ $. (Do not include the dollar signs ($). Negative amount should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) (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
Initial investment = 24,000,000
This is depreciated on a straight line basis for 7 years, which will provide depreciation tax shield each year
Cash flow generated each year = EBIT *(1-tax)
EBIT = Revenue - cost
Best Case:
New golf balls sales are +6% = 24,000 * (1+6%) = 25440
Decrease in sales of high price clubs is -6% = 5000 * (1-6%) = 4700
Increase in sales of cheap clubs is +6% = 4000 * (1+6%) = 4240
So EBIT can be calculated as follows
EBIT = 25440 * (760-320) - 4700 * (1220 - 620) + 4240 * (420-150) - 8400000 = 1,118,400.00
Year 0 cash flows = -24,000,000-1,105,000 = -25,105,000
Year 7 cash flows = 1,118,400.00+1,105,000 = 2,223,400
So all cash flows are as follows
NPV can be calculated as follows
NPV = NPV(9%,A1:A7)-25105000 = -14,462,668.31
Worst Case:
New golf balls sales are -6% = 24,000 * (1-6%) = 22560
Decrease in sales of high price clubs is +6% = 5000 * (1+6%) = 5300
Increase in sales of cheap clubs is -6% = 4000 * (1-6%) = 3760
So EBIT can be calculated as follows
EBIT = 22560 * (760-320) - 5300 * (1220 - 620) + 3760 * (420-150) - 8400000 = -638400
Year 0 cash flows = -24,000,000-1,105,000 = -25,105,000
Year 7 cash flows = -638,400+1,105,000 = 466,600
So all cash flows are as follows
NPV can be calculated as follows
NPV = NPV(9%,A1:A7)-25105000 = -19,767,803.23
Cash flow Tax Rate After tax Cash Flow Machine Depreciation value Depreciation Tax Shield Total net cash flows Year 0 (25,105,000.00) 40% (25,105,000.00) - - (25,105,000.00) Year 1 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 2 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 3 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 4 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 5 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 6 1,118,400.00 40% 671,040.00 3,428,571.43 1,371,428.57 2,042,468.57 Year 7 2,223,400.00 40% 1,334,040.00 3,428,571.43 1,371,428.57 2,705,468.57