McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2781189 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $870 per set and have a variable cost of $470 per set. The company has spent $157,000 for a marketing study that determined the company will sell 61,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,200 sets of its high-priced clubs. The high-priced clubs sell at $1,170 and have variable costs of $770. The company will also increase sales of its cheap clubs by 11,700 sets. The cheap clubs sell for $510 and have variable costs of $265 per set. The fixed costs each year will be $9,170,000. The company has also spent $1,180,000 on research and development for the new clubs. The plant and equipment required will cost $29,190,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,370,000 that will be returned at the end of the project. The tax rate is 30 percent, and the cost of capital is 10 percent. Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained or lost are uncertain.) (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
NPV:
Best-case $____________
Worst-case $___________
Explanation / Answer
The cash flows before tax in each year in each case would be -
Cash flows = Contribution from sale of new clubs - Contribution lost due to decrease in sales of high cost clubs + Contribution due to Increase in sales of cheap clubs - Fixed Cost - Taxes + Tax shield from depreciation
Also, we will not consider the R&D costs and marketing study costs as they are past/ sunk costs and should not influence the decision. So, Cash outflows in each case would be the cost of plant & equipment of $29,190,000
Depreciation tax shield per year in each case = ($29,190,000 / 7) x 30% = $1,251,000
Best-case Scenario
The Best-case scenario would be when sales drop from high priced clubs are less than estimated by 10% and increased sales of cheap ones are more than estimated by 10%.
Sales drop of high priced clubs = 10,200 - 10% = 9,180
Sales increase of cheap clubs = 11,700 + 10% = 12,870
Worst-case Scenario
The Best-case scenario would be when sales drop from high priced clubs are more than estimated by 10% and increased sales of cheap ones are less than estimated by 10%.
Sales drop of high priced clubs = 10,200 + 10% = 11,220
Sales increase of cheap clubs = 11,700 - 10% = 10,530
NPV Particulars Amount ($) Sale of new clubs 61,000 x (870 - 470) = 24,400,000 Add: Increased Sale of cheap clubs 12,870 x (510 - 265) = 3,153,150 Less: Decreased Sale of High price clubs 9,180 x (1170 - 770) = 3,672,000 Less: Fixed Cost 9,170,000 Cash Inflows before Tax 14,711,150 Less: Tax @ 30% 4,413,345 Cash Inflows after tax 10,297,805 Add: Depreciation Tax shield 1,251,000 Total Cash Infows 11,548,805 Cumulative PVF (10%, 7 years) 4.86841881764 Present Value of Cash Inflows 56,224,419.58 Less: Initial cash Outflow 29,190,000 NPV 27,034,419.58