McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2787703 • 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.)
Explanation / Answer
The above is the base case scenario NPV, in which the marketing study and R&D expenses are considered as sunk cost and not considered in the analysis.
Sales = New club unit x Unit Price
VC = New club unit x VC
Cannibalization = Loss of net sales from high priced club plus additional net sales from cheap club
Depreciation = Investment / No. of years
Now, best-case scenario is when price and unit sales of new clubs are up 10% and its VC is down 10%. Also, unit sales of high-priced clubs are down 10% and unit sales of cheap clubs are up 10%. Nothing is mentioned about initial investment, net working capital and fixed cost. So, I assume them to be constant.
Worst-case scenario is when price and unit sales of new clubs are down 10% and its VC is up 10%. Also, unit sales of high-priced clubs are up 10% and unit sales of cheap clubs are down 10%.
0 1 2 3 4 5 6 7 Investment -$29,190,000 NWC -$1,370,000 $1,370,000 Sales $53,070,000 $53,070,000 $53,070,000 $53,070,000 $53,070,000 $53,070,000 $53,070,000 VC -$28,670,000 -$28,670,000 -$28,670,000 -$28,670,000 -$28,670,000 -$28,670,000 -$28,670,000 FC -$9,170,000 -$9,170,000 -$9,170,000 -$9,170,000 -$9,170,000 -$9,170,000 -$9,170,000 Cannibalization -$1,213,500 -$1,213,500 -$1,213,500 -$1,213,500 -$1,213,500 -$1,213,500 -$1,213,500 Depreciation -$4,170,000 -$4,170,000 -$4,170,000 -$4,170,000 -$4,170,000 -$4,170,000 -$4,170,000 EBT $9,846,500 $9,846,500 $9,846,500 $9,846,500 $9,846,500 $9,846,500 $9,846,500 Tax (30%) -$2,953,950 -$2,953,950 -$2,953,950 -$2,953,950 -$2,953,950 -$2,953,950 -$2,953,950 Net Income $6,892,550 $6,892,550 $6,892,550 $6,892,550 $6,892,550 $6,892,550 $6,892,550 Cash Flows -$30,560,000 $11,062,550 $11,062,550 $11,062,550 $11,062,550 $11,062,550 $11,062,550 $12,432,550 NPV $24,000,153.21