McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2778178 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $720 per set and have a variable cost of $320 per set. The company has spent $142,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,700 sets of its high-priced clubs. The high-priced clubs sell at $1,020 and have variable costs of $620. The company will also increase sales of its cheap clubs by 10,200 sets. The cheap clubs sell for $360 and have variable costs of $190 per set. The fixed costs each year will be $9,020,000. The company has also spent $1,030,000 on research and development for the new clubs. The plant and equipment required will cost $28,140,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,220,000 that will be returned at the end of the project. The tax rate is 36 percent, and the cost of capital is 10 percent.
Calculate the payback period. Calculate the NPV. Calculate the IRR.
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $720 per set and have a variable cost of $320 per set. The company has spent $142,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,700 sets of its high-priced clubs. The high-priced clubs sell at $1,020 and have variable costs of $620. The company will also increase sales of its cheap clubs by 10,200 sets. The cheap clubs sell for $360 and have variable costs of $190 per set. The fixed costs each year will be $9,020,000. The company has also spent $1,030,000 on research and development for the new clubs. The plant and equipment required will cost $28,140,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,220,000 that will be returned at the end of the project. The tax rate is 36 percent, and the cost of capital is 10 percent.
Explanation / Answer
Marketing and Research and Development costs are sunk costs. Hence, they are not a part of the calculation.
Cash Flow due to sales of new golf clubs = 54000 * (720 – 320) = $21,600,000
Reduction in cash flow due to loss in sales of high priced clubs = 8700 * (1020 - 620) = $3,480,000
Cash Flow due to increase in sales cheap clubs = 10200 * (360 -190) = $1,734,000
Annual Depreciation = 28,140,000/7 = $4,020,000
Fixed Cost = $9,020,000
Operating Cash Flow in years 1 to 7 = (21600000 + 1734000 – 3480000 – 9,020,000) * (1 – 0.36) + 0.36 * 4020000 = $8,380,960
Initial Investment = 28,140,000 + 1,220,000 = $29,360,000
Terminal Cash flow in year 7 = $1,220,000
Total Cash Flow in year 7 = 8,380,960 + 1,220,000 = $9,600,960
Hence, the cash flow table looks like:
The NPV is the sum of the discounted cash flows = $12,068,076.28
IRR of the project = 21.45%
Cash Flow in year 1 + Cash flow in year 2 + Cash Flow in year 3 =8,380,960 * 3 = $25,142,880
Payback Period = 3 + (29,360,000 – 25,142,880)/ 8,380,960 = 3 + 0.502 = 3.503 years
Year Cash Flow Discounted Cash Flow 0 -29360000 -29360000.00 1 8380960 7619054.55 2 8380960 6926413.22 3 8380960 6296739.29 4 8380960 5724308.45 5 8380960 5203916.77 6 8380960 4730833.43 7 9600960 4926810.57 NPV 12068076.28