McGilla Golf has decided to sell a new line of golf clubs. The company would lik
ID: 2763571 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The company 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 $740 per set and have a variable cost of $340 per set. The company has spent $144,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,900 sets of its high-priced clubs. The high-priced clubs sell at $1,040 and have variable costs of $640. The company will also increase sales of its cheap clubs by 10,400 sets. The cheap clubs sell for $380 and have variable costs of $200 per set. The fixed costs each year will be $9,040,000. The company has also spent $1,050,000 on research and development for the new clubs. The plant and equipment required will cost $28,280,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,240,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent. What is the sensitivity of the NPV to each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.) NPV NPV/P $ NPV/Q $
Explanation / Answer
Ans:- Sensitivity of the net present value=
n [Q (P – V) – F – D] (1 – T) + D S
NPV = S ------------------------------------------------ + --------- – I
t = 1 (1+ k)t (1+k)n
where,
NPV = Net present value of the project
Q = Number of units sold annually
P = Selling price per units
V = Variable cost per unit
F = Total fixed costs, excluding depreciation and interest
D = Annual depreciation charge
T = Income tax rate
k = Cost of capital
n = Project life in years
S = Net salvage value
I = Initial costs
Finding NPV/P
The marketing study and the research and development are both sunk costs and should be ignored. We will calculate the sales and variable costs first.
Since we will lose sales of the expensive clubs again sales of the cheap clubs, these must be accounted for as erosion.
Sales
New clubs $740 x 56,000 = 41440000
Exp. Clubs $ 1040 x (-8900) = -9256000
Cheap clubs $ 380 x 10,400 =3952000
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=36136000
for the variable costs, we must include the units gained or lost from the existing clubs.note that the variable costs of the expensive clubs are in inflow. if we are not producing the sets anymore we will save the variable costs which is in flow.so,
var. costs
New clubs -$340 x 56,000 = - 19040000
Exp. clubs - $ 640 x- 8900 = 5696000
Cheap clubs -$ 200 x 10400 = - 2080000
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= 15424000
The pro forma income statement will be
Sales $ 36,136,000
Variable costs $ 15,424,000
fixed costs $9,040,000
Depreciation $ 28,280,000
EBIT $ 16,608,000
Taxes 40 % on EBIT = $ 6,643,200
Net Income (EBIT- tax) = $ 9,964,800
OCF= NI + Depreciation = $ 9,964,800 + $ 28,280,000 =$ 38,244,800