McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2749554 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $800 per set and have a variable cost of $400 per set. The company has spent $144,000 for a marketing study that determined the company will sell 52,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 14,000 sets of its high-priced clubs. The high-priced clubs sell at $1,200 and have variable costs of $800. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $400 and have variable costs of $200 per set. The fixed costs each year will be $7,200,000. The company has also spent $1,008,000 on research and development for the new clubs. The plant and equipment required will cost $18,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $958,000 that will be returned at the end of the project. The tax rate is 36 percent, and the cost of capital is 8 percent. McGilla Golf 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 sensitivity of the NPV to changes in the price is $ and the sensitivity of the NPV to the quantity sold is $. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
McGilla Golf Sensitivity to changes In price of new clubs Changes in quantity 10% increase 10% decrease 10% increase 10% decrease Increase of Contribution on the new line of golf clubs =(800-400)52000 20800000 24960000 16640000 22880000 18720000 Less: Loss of Contribution on high price clubs (1200-800)*14000 5600000 5600000 5600000 5600000 5600000 Add: Increase in contribution on cheap clubs ((400-200)*10000 2000000 2000000 2000000 2000000 2000000 Net increase in contribution on account of this proposal 17200000 21360000 13040000 19280000 15120000 Less: Additional fixed costs 7200000 7200000 7200000 7200000 7200000 Less: Depreciaton-straight line = 18000000/7 2571429 2571429 2571429 2571429 2571429 Less: Amortisation of Marketing study and R&D costs 163543 163543 163543 163543 163543 (144000+1008000)/7 Incremental Profit before tax per year 7265029 11425029 3105029 9345029 5185029 Tax at 36% 2615410 4113010 1117810 3364210 1866610 PAT 4649618 7312018 1987218 5980818 3318418 Add: Depreciation and amortisations 2734971 2734971 2734971 2734971 2734971 Incremental cash inflow per year 7384590 10046990 4722190 8715790 6053390 Initial Investment ---Plant and machinery 18000000 18000000 18000000 18000000 18000000 Addl working capital 958000 958000 958000 958000 958000 Total Initial Investment 18958000 18958000 18958000 18958000 18958000 (Expenses on marketing study and R&D are sunk costs and not to be considered as initial investment, but provide tax relief) Cost of Capital 8% PVIFA at 8% for 7 years 5.206 5.206 5.206 5.206 5.206 PV of Cash Flows 38444174 52304628 24583720 45374401 31513947 PV of Working Capital recovery at the end of the seventh year = 958000*0.583 558514 558514 558514 558514 558514 39002688 52863142 25142234 45932915 32072461 Less: otal Initial Investment 18958000 18958000 18958000 18958000 18958000 NPV of the Investment Proposal 20044688 33905142 6184234 26974915 13114461 % change in NPV from the base estimate 69.15 -69.15 34.57 -34.57 CONCLUSION: When the price of the new golf club is increased/decreased by 10% the variation in NPV is twice the variation in NPV due to a similar increase in quantity.