McGilla Golf has decided to sell a new line of golf clubs. The company would lik
ID: 2781219 • 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 $790 per set and have a variable cost of $390 per set. The company has spent $149,000 for a marketing study that determined the company will sell 53,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,400 sets of its high-priced clubs. The high-priced clubs sell at $1,090 and have variable costs of $690. The company will also increase sales of its cheap clubs by 10,900 sets. The cheap clubs sell for $430 and have variable costs of $225 per set. The fixed costs each year will be $9,090,000. The company has also spent $1,100,000 on research and development for the new clubs. The plant and equipment required will cost $28,630,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,290,000 that will be returned at the end of the project. The tax rate is 34 percent, and the cost of capital is 10 percent. What is the sensitivity of the NPV to each of these variables?
NPV/P$ ?? NPV/Q$ ??
Explanation / Answer
The marketing study and the research and development both are sunk costs therefore it will not be included in NPV calculation.
The initial cost is the equipment plus the net working capital, therefore
Initial cost = $28,630,000 + $1,290,000 = $29,920,000
Now calculate the sales and variable costs including the loss of sales of the High-priced clubs and gain sales of the cheap clubs. Therefore total sales for the new project will be
Sales/Revenue:
New clubs: $790 * 53,000 = $41,870,000
High-priced clubs: $1,090 * -9,400 = -$10,246,000
Cheap clubs: $430 * 10,900 = $4,687,000
Total sales = $41,870,000 - $10,246,000 + $4,687,000 = $36,311,000
Variable costs:
New clubs: $390 * 53,000 = $20,670,000
High-priced clubs: $690 * -9,400 = -$6,486,000
Cheap clubs: $225 * 10,900 = $2,452,000
Total Variable costs = $20,670,000 - $6,486,000 + $2,452,000 = $16,636,500
The fixed costs = $9,090,000 per year
Cost of Equipment 28630000 Sales/Revenue: Increase in net working capital 1290000 New clubs: ($790 * 53,000) $41,870,000 total initial cost 29920000 High-priced clubs: ($1,090 * -9,400) ($10,246,000) Fixed costs 9090000 Cheap clubs: ($430 * 10,900) $4,687,000 Total sales $36,311,000 Normal Case NPV Calculation: Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Operating profit (Revenue-variable costs-fixed costs) Before taxes cash flow (BTCF) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *34%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,630,000 0 0 $0 -$29,920,000 -$29,920,000 1 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $7,614,882 2 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $6,922,620 3 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $6,293,291 4 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $5,721,173 5 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $5,201,067 6 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $10,584,500 $6,494,500 $2,208,130 $4,286,370 $8,376,370 $4,728,242 7 $4,090,000 $36,311,000 $16,636,500 $10,584,500 $11,874,500 $7,784,500 $2,646,730 $5,137,770 $9,227,770 $4,735,305 NPV of new Project (Sum of PVs) $11,296,580 If price increased by $50 of new clubs Sales/Revenue: Variable costs: New clubs: ($790 * 54,000) $44,520,000 $20,670,000 High-priced clubs: ($1,090 * -9,400) ($10,246,000) ($6,486,000) Cheap clubs: ($430 * 10,900) $4,687,000 $2,452,500 Total sales $38,961,000 $16,636,500 NPV Calculation ($50 increase in price) Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Operating profit (Revenue-variable costs-fixed costs) Before taxes cash flow (BTCF) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *34%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,630,000 0 0 $0 -$29,920,000 -$29,920,000 1 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $9,204,882 2 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $8,368,074 3 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $7,607,340 4 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $6,915,764 5 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $6,287,058 6 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $13,234,500 $9,144,500 $3,109,130 $6,035,370 $10,125,370 $5,715,507 7 $4,090,000 $38,961,000 $16,636,500 $13,234,500 $14,524,500 $10,434,500 $3,547,730 $6,886,770 $10,976,770 $5,632,819 NPV of new Project (Sum of PVs) $19,811,445 change in NPV $8,514,865 Change in Price $50 Change in NPV/Change in Price $170,297.29 $1 increase in price will increse NPV by $170,297.29 If Quantity increased by 1000 of new clubs Sales/Revenue: Variable costs: New clubs: ($790 * 54,000) $42,660,000 $21,060,000 High-priced clubs: ($1,090 * -9,400) ($10,246,000) ($6,486,000) Cheap clubs: ($430 * 10,900) $4,687,000 $2,452,500 Total sales $37,101,000 $17,026,500 NPV Calculation (1000 increase in Quantity) Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Operating profit (Revenue-variable costs-fixed costs) Before taxes cash flow (BTCF) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *34%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,630,000 0 0 $0 -$29,920,000 -$29,920,000 1 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $7,854,882 2 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $7,140,802 3 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $6,491,638 4 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $5,901,489 5 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $5,364,990 6 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $10,984,500 $6,894,500 $2,344,130 $4,550,370 $8,640,370 $4,877,264 7 $4,090,000 $37,101,000 $17,026,500 $10,984,500 $12,274,500 $8,184,500 $2,782,730 $5,401,770 $9,491,770 $4,870,779 NPV of new Project (Sum of PVs) $12,581,843 change in NPV $1,285,263 Change in Quantity 1,000 Change in NPV/Change in Quantity $1,285.26 1 unit increase in quantity will increse NPV by $1,285.26