McGilla Golf has decided to sell a new line of golf clubs and would like to know
ID: 2771158 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs and would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs solid. Te 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 59,000sets per year for seven years. The marketing study also determined that the company will lose sales of 9200 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 each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places(e.g., 32.16).)Explanation / Answer
Calculation of Cash inflows
Contribution will be calculated first. = Sales – Variable Cost
(New Clubs – High Priced clubs + Cheap Clubs)
New Club:-
(770-370) = 400 Per New club
Total Contribution= 400 *59000 = 2, 36, 00,000 (A)
High Priced clubs
(1070 – 670) = 400 Per High Priced club
Total Contribution = 400 * 9200 = 36, 80,000 (The Company will lose the sale of High Priced Clubs) (B)
Cheap Clubs
(410 – 215) = 195 per cheap club
Total contribution = 195 *10700 = 20, 86,500 (The company will increase the sale of cheap clubs) (C)
Income Statement
Contribution: - (A) – (B) + (C) 2, 20, 06,500
(-) Fixed Costs
= Profit before Depreciation 1, 29, 36,500
(-) Depreciation 40, 70,000 (2, 84, 90,000/7)
Profit before Tax 88, 66,500
(-) Tax 38 % 33, 69, 270
Profit after Tax 54, 97, 230
+ Depreciation 40, 70,000
Cash Inflow 95, 67,230
Cumulative Present Value factor for Seven Year @ 12 % = 4.5638
Present value of Cash inflow = 4.5638 *95, 67,230 = 4, 36, 62,924.27 (a)
+ Working Capital (12, 70, 000 * 0.452) = 5, 74,040 (b)
Total Present value of Cash inflow (a) + (b) = 4, 42, 36,964.27 (Z)
Note: - Salvage value of working capital at the end of year is assumed at 100 % & therefore, it is multiplied by present value factor of Seventh year @ 12 % i.e. 0.452
Total Cash outflow at the beginning
Equipment = 2, 84, 90,000
Working capital = 12, 70, 000
Research &Development = 10, 80, 000 (Assumed at the beginning of Year)
On Marketing Study = 1, 47,000 (Assumed at the beginning of Year)
Total Cash outflow 3, 09, 87,000 (R)
NPV = (Z) – (R) = 1, 32, 49,964.27
Let Selling price per new club be “S” so that project would break even with 0 NPV.
3, 09, 87,000 = [(S – 370) * 59,000] – 9, 07, 0000
S = 1049 (approx)
So the Sensitivity = (770 – 1049 /770) * 100 = 36.23 % (Which represents a Jump / Hike)
From :- NILESH SHARDA (CHARTERED ACCOUNTANT)