McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2794890 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $860 per set and have a variable cost of $460 per set. The company has spent $156,000 for a marketing study that determined the company will sell 60,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,100 sets of its high-priced clubs. The high-priced clubs sell at $1,160 and have variable costs of $760. The company will also increase sales of its cheap clubs by 11,600 sets. The cheap clubs sell for $500 and have variable costs of $260 per set. The fixed costs each year will be $9,160,000. The company has also spent $1,170,000 on research and development for the new clubs. The plant and equipment required will cost $29,120,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,360,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 12 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.)
Please BOLD final answers
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $860 per set and have a variable cost of $460 per set. The company has spent $156,000 for a marketing study that determined the company will sell 60,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,100 sets of its high-priced clubs. The high-priced clubs sell at $1,160 and have variable costs of $760. The company will also increase sales of its cheap clubs by 11,600 sets. The cheap clubs sell for $500 and have variable costs of $260 per set. The fixed costs each year will be $9,160,000. The company has also spent $1,170,000 on research and development for the new clubs. The plant and equipment required will cost $29,120,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,360,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 12 percent.
Explanation / Answer
Normal Upper Bound + 10% Lower Bound - 10% Unit Sales 59,000 64900 53100 Price $850 $935 $765 Variable Costs $450 $495 $405 Fixed Costs $9,150,000 $10,065,000 $8,235,000 Sales lost (expensive) 10,000 11000 9000 Sales gained (cheap) 11,500 12650 10350 Base Case Best Case Worst Case Unit Sales 59,000 64,900 53,100 Price $850 $935 $765 Variable Costs $450 $405 $495 Fixed Costs $9,150,000 $8,235,000 $10,065,000 Sales lost (expensive) 10,000 9000 11000 Sales gained (cheap) 11,500 12650 10350 Best Case Sales New clubs = $935× 64,900 $60,681,500 High-priced clubs = $1150 x -9000 -$10,350,000 Cheap clubs = $490 x 12650 $6,198,500 Total sales $56,530,000 Variable costs New clubs = $405 × 64,900 $26,284,500 High-priced clubs = $750 x -9,000 -$6,750,000 Cheap clubs = $255 x 12650 $3,225,750 Total Variable costs $22,760,250 Pro forma income statement Sales $56,530,000 Less: variable cost -$22,760,250 Less: Fixed cost -$8,235,000 Less: Depreciation = $29,050,000/7 -$4,150,000 EBT $21,384,750 Taxes @ 40% -$8,553,900 Net Income $12,830,850 OCF = NI + Depreciation $16,980,850 Initial Investment $29,050,000 Add: working capital $1,350,000 Total cash flow in year 0 $30,400,000 NPV Year Cash flow PV @ 10% Present Value 0 -$30,400,000 1 -$30,400,000 1 $16,980,850 0.909090909 $15,437,136.36 2 $16,980,850 0.826446281 $14,033,760.33 3 $16,980,850 0.751314801 $12,757,963.94 4 $16,980,850 0.683013455 $11,598,149.03 5 $16,980,850 0.620921323 $10,543,771.85 6 $16,980,850 0.56447393 $9,585,247.14 7 $16,980,850 0.513158118 $8,713,861.03 Working Capital 7 $1,350,000 0.513158118 $692,763.46 Best Case NPV $52,962,653.14 Worst Case Sales New clubs = $765× 53100 $40,621,500 High-priced clubs = $1150 x -11000 -$12,650,000 Cheap clubs = $490 x 10350 $5,071,500 Total sales $33,043,000 Variable costs New clubs = $495 × 53100 $26,284,500 High-priced clubs = $750 x -11,000 -$8,250,000 Cheap clubs = $255 x 10350 $2,639,250 Total Variable costs $20,673,750 Pro forma income statement Sales $33,043,000 Less: variable cost -20673750 Less: Fixed cost -$10,065,000 Less: Depreciation = $29,050,000/7 -$4,150,000 EBT -$1,845,750 Taxes -$738,300 Net Income -$1,107,450 OCF = NI + Depreciation $3,042,550 Initial Investment $29,050,000 Add: working capital $1,350,000 Total cash flow in year 0 $30,400,000 NPV Year Cash flow PV @ 10% Present Value 0 -$30,400,000 1 -$30,400,000 1 $3,042,550 0.909090909 $2,765,954.55 2 $3,042,550 0.826446281 $2,514,504.13 3 $3,042,550 0.751314801 $2,285,912.85 4 $3,042,550 0.683013455 $2,078,102.59 5 $3,042,550 0.620921323 $1,889,184.17 6 $3,042,550 0.56447393 $1,717,440.16 7 $3,042,550 0.513158118 $1,561,309.23 Working Capital 7 $1,350,000 0.513158118 $692,763.46 Worst Case NPV -$14,894,828.87