Problem 11-22 Sensitivity Analysis [LO1] McGilla Golf has decided to sell a new
ID: 2794914 • Letter: P
Question
Problem 11-22 Sensitivity Analysis [LO1] 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 $810 per set and have a variable cost of $410 per set. The company has spent $151,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,600 sets of its high-priced clubs The high-priced clubs sell at $1,110 and have variable costs of $710. The company will also increase sales of its cheap clubs by 11,100 sets. The cheap clubs sell for $450 and have variable costs of $235 per set. The fixed costs each year will be $9,110,000. The company has also spent $1,120,000 on research and development for the new clubs. The plant and equipment required will cost $28,770,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,310,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent. What is the sensitivity of the NPV to each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.) NPV ANPVIAP S 160657.0Explanation / 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 = $28,770,000 + $1,310,000 = $30,080,000
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: $810 * 55,000 = $44,550,000
High-priced clubs: $1,110 * -9,600 = -$10,656,000
Cheap clubs: $450 * 11,100 = $4,995,000
Total sales = $44,550,000 -$10,656,000 + $4,995,000 = $38,889,000
Variable costs:
New clubs: $410 * 55,000 = $22,550,000
High-priced clubs: $710 * -9,600 = -$6,816,000
Cheap clubs: $235 * 11,100 = $2,608,500
Total Variable costs = $22,550,000 -$6,816,000 + $2,608,500 = $18,342,500
The fixed costs = $9,110,000 per year
Cost of Equipment $28,770,000 Sales/Revenue: Variable costs Increase in net working capital $1,310,000 New clubs: ($810 * 55,000) $44,550,000 $22,550,000 total initial cost 30080000 High-priced clubs: ($1,110 * -9,600) ($10,656,000) ($6,816,000) Fixed costs $9,110,000 Cheap clubs: ($450 * 11,100) $4,995,000 $2,608,500 Total sales $38,889,000 $18,342,500 Normal Case NPV Calculation: Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Before taxes cash flow (BTCF) or Operating profit (Revenue-variable costs-fixed costs) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *40%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,770,000 0 0 $0 -$30,080,000 -$30,080,000 1 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $7,732,636 2 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $7,029,669 3 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $6,390,609 4 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $5,809,644 5 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $5,281,495 6 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $4,801,359 7 $4,110,000 $38,889,000 $18,342,500 $11,436,500 $7,326,500 $2,930,600 $4,395,900 $8,505,900 $4,364,872 NPV of new Project (Sum of PVs) $11,330,284 If price increased by $50 of new clubs Sales/Revenue: Variable costs New clubs: $47,300,000 $22,550,000 High-priced clubs: ($10,656,000) ($6,816,000) Cheap clubs: $4,995,000 $2,608,500 Total sales $41,639,000 $18,342,500 NPV Calculation ($50 increase in price) Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Before taxes cash flow (BTCF) or Operating profit (Revenue-variable costs-fixed costs) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *40%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,770,000 0 0 $0 -$30,080,000 -$30,080,000 1 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $9,232,636 2 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $8,393,306 3 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $7,630,278 4 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $6,936,616 5 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $6,306,015 6 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $5,732,741 7 $4,110,000 $41,639,000 $18,342,500 $14,186,500 $10,076,500 $4,030,600 $6,045,900 $10,155,900 $5,211,583 NPV of new Project (Sum of PVs) $19,363,175 change in NPV $8,032,891 Change in Price $50 Change in NPV/Change in Price $160,657.82 $1 increase in price will increse NPV by $160,657.82 If Quantity increased by 1000 of new clubs Sales/Revenue: Variable costs New clubs: $45,360,000 $22,550,000 High-priced clubs: ($10,656,000) ($6,816,000) Cheap clubs: $4,995,000 $2,608,500 Total sales $39,699,000 $18,342,500 NPV Calculation (1000 increase in Quantity) Year (n) Cost of Equipment and Depreciation (Asset's Value/7) Sales/Revenue Variable costs Before taxes cash flow (BTCF) or Operating profit (Revenue-variable costs-fixed costs) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *40%) After Tax Net Income (taxable income - taxes) Cash Flow = ( Net Income + depreciation) PV at 10% [PV= CF/(1+10%)^n] 0 $28,770,000 0 0 $0 -$30,080,000 -$30,080,000 1 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $8,174,455 2 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $7,431,322 3 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $6,755,748 4 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $6,141,589 5 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $5,583,262 6 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $5,075,693 7 $4,110,000 $39,699,000 $18,342,500 $12,246,500 $8,136,500 $3,254,600 $4,881,900 $8,991,900 $4,614,266 NPV of new Project (Sum of PVs) $13,696,335 change in NPV $2,366,052 Change in Quantity 1,000 Change in NPV/Change in Quantity $2,366.05 1 unit increase in quantity will increse NPV by $2,366.05