McGilla Golf is evaluating a new golf club. The clubs will sell for $770 per set
ID: 2763056 • Letter: M
Question
McGilla Golf is evaluating a new golf club. The clubs will sell for $770 per set and have a variable cost of $370 per set. The company has spent $147,000 for a marketing study that determined the company will sell 59,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,200 sets of its high-priced clubs. The high-priced clubs sell at $1,070 and have variable costs of $670. The company will also increase sales of its cheap clubs by 10,700 sets. The cheap clubs sell for $410 and have variable costs of $215 per set. The fixed costs each year will be $9,070,000. The company has also spent $1,080,000 on research and development for the new clubs. The plant and equipment required will cost $28,490,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,270,000 that will be returned at the end of the project. The tax rate is 38 percent, and the cost of capital is 12 percent.
What is the sensitivity of the NPV to the price and quantity of the new clubs? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
NPV/P $_______
NPV/Q $_______
Explanation / Answer
Contribution from New set of Golf Club = Selling Price - Variable Cost
= $770 - $370
= $400 per set
No .of Sets to be sold per year = 59,000 per year for 7 Years
Contribution per year of New Clubs = 59,000 x $400
= $23,600,000 - (A)
Contribution lost of High Priced Clubs = 9,200 x ($1,070 - $670)
= $3,680,000 - (B)
Contribution earned from sale of Cheap Clubs = 10,700 x ($410 - $215)
= $2,086,500 - (C)
Total Cash Inflows Per Year = (A) - (B) + (C)
= $23,600,000 - $3,680,000 + $2,086,500
= $22,006,500
Total Cash Out flows Per Year = $9,070,000
Net cash flows Net of Tax per year for 1 - 7 year = ($22,006,500 - $9,070,000) x (1 - 0.38)
= $12,936,500 x 0.62
= $8,020,630
Depreciation per Year = $28,490,000 / 7 = $4,070,000 per year
(Assuming life to be seven years, and no salvage value as nothing mentioned in question)
Tax Savings on Depreciation per year = $4,070,000 x (0.38)
= $1,546,600
If Price of New Clubs increases to $870 per set
Then, Net Cash Flows net of Tax = (($870 - $370) x 59,000) - $3,680,000 + $2,086,500 - $9,070,000) x (1-0.38)
= ($29,500,000 - $1,593,500 - $9,070,000) x (0.62)
= $11,678,630
Then NPV = (-)29,760,000.00 + ($11,678,630 + $1,546,600) (4.5638) + $574,421.00
= $31,171,725.67
Sensitivity of NPV to Price = ($14,477,345.27 - $31,171,725.67) / ($770 - $870)
= 166,943.80
If Quantity of New Clubs increases to 60,000 sets
Then, Net Cash Flows net of Tax = (($770 - $370) x 60,000) - $3,680,000 + $2,086,500 - $9,070,000) x (1-0.38)
= ($24,000,000 - $1,593,500 - $9,070,000) x (0.62)
= $8,268,630
Then NPV = (-)29,760,000.00 + ($8,268,630 + $1,546,600) (4.5638) + $574,421.00
= $15,586,348.67
Sensitivity of NPV to Price = ($14,477,345.27 - $15,586,348.67) / (59,000 - 60,000)
= 1,109.00
Period Net Cash Flows ($) Savings on Depreciation ($) Net Cash Flows ($) Present Value Factor @ 12% Present Value ($) 0 (30,987,000) (29,760,000) 1 (29,760,000.00) 1-7 8,020,630 1,546,600 9,567,230 4.5638 43,662,924.27 7 1,270,000 1,270,000 0.4523 574,421.00 Net Present Value ($) 14,477,345.27