Problem 11-22 Sensitivity Analysis [LO1] McGilla Golf has decided to sell a new
ID: 2796460 • 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 $710 per set and have a variable cost of $310 per set. The company has spent $141,000 for a marketing study that determined the company will sell 53,000 sets determined that the company will lose sales of 8,600 sets of its high-priced clubs. The high-priced clubs sell at $1,010 and have variable costs of $610. The company will also increase sales of its cheap clubs by 10,100 sets. The cheap clubs sell for $350 and have variable costs of $185 per set. The fixed costs each year will be $9,010,000. The company has also spent $1,020,000 on research and development for the new clubs. The plant and equipment required will cost $28,070,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,210,000 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? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.) per year for seven years. The marketing study also NPV ANPVIAP ANPVIAQExplanation / Answer
Marketing, R&D costs are sunk costs and will not be considered as part of analysis.
Plant and Equipment Cost =$28,070,000
Annual Depreciation using Straight Line =$28,070,000/7 =$4,010,000
Income Statement
Sales from New Set $ 37,630,000 [710x53000=37,630,000]
Less Variable Cost $ -16,430,000 [310x53000=16,430,000]
Less Sales lost of High Price Clubs $ - 8,686,000 [8600x1010=8,686,000]
Add Gain in Variable Costs HP Clubs $ 5,246,000 [8600x610 = 5,246,000]
Add Gain in Sales of LP Clubs $ 3,535,000 [10100x350=3,535,000]
Less Variable Costs LP Clubs $ -1,868,500 [10100x185 =1,868,500]
Less Fixed Costs $ -9,010,000
Less Annual Depreciation $ -4,010,000
Annual EBIT $ 6,406,500
Annual Cash Flows = EBIT x (1-T) + D
=$ 6,406,500x(1-0.34) + 4,010,000
=$ 4,228,290 + 4,010,000
=$ 8,238,290
NPV for the Project = -28,070,000 -1,210,000 + 8,238,000x{(1-(1+0.10)-7)/0.10} + 1,210,000/1.107
= -29,280,000 + 40,106,034 + 620,921
= 11,446,955
NPV Sensitivity to Price
Let us chose new selling price for the new line of Golf Clubs i.e. $800
New Income Statement
Sales from New Set $ 42,400,000 [800x53000=42,400,000]
Less Variable Cost $ -16,430,000 [310x53000=16,430,000]
Less Sales lost of High Price Clubs $ - 8,686,000 [8600x1010=8,686,000]
Add Gain in Variable Costs HP Clubs $ 5,246,000 [8600x610 = 5,246,000]
Add Gain in Sales of LP Clubs $ 3,535,000 [10100x350=3,535,000]
Less Variable Costs LP Clubs $ -1,868,500 [10100x185 =1,868,500]
Less Fixed Costs $ -9,010,000
Less Annual Depreciation $ -4,010,000
Annual EBIT $ 11,177,000
Annual Cash Flows = EBIT x (1-T) + D
=$ 11,177,000x(1-0.34) + 4,010,000
=$ 7,376,820 + 4,010,000
=$ 11,386,820
NPV for the Project = -28,070,000 -1,210,000 + 11,386,820x{(1-(1+0.10)-7)/0.10} + 1,210,000/1.107
= -29,280,000 + 55,435,809 + 620,921
= 26,776,730
Thus, NPV sensitivity to Price = (26,776,730-11,446,955)/(800-710) =$170,331
So, for every dollar increase in selling price, the NPV increases by $170,331
NPV Sensitivity to Quantity
Let us chose new selling quantity for the new line of Golf Clubs i.e. 55,000 sets/year
New Income Statement
Sales from New Set $ 39,050,000 [710x55000=39,050,000]
Less Variable Cost $ -16,430,000 [310x53000=16,430,000]
Less Sales lost of High Price Clubs $ - 8,686,000 [8600x1010=8,686,000]
Add Gain in Variable Costs HP Clubs $ 5,246,000 [8600x610 = 5,246,000]
Add Gain in Sales of LP Clubs $ 3,535,000 [10100x350=3,535,000]
Less Variable Costs LP Clubs $ -1,868,500 [10100x185 =1,868,500]
Less Fixed Costs $ -9,010,000
Less Annual Depreciation $ -4,010,000
Annual EBIT $ 7,827,000
Annual Cash Flows = EBIT x (1-T) + D
=$ 7,827,000x(1-0.34) + 4,010,000
=$ 4,696,200 + 4,010,000
=$ 8,706,000
NPV for the Project = -28,070,000 -1,210,000 + 8,706,000x{(1-(1+0.10)-7)/0.10} + 1,210,000/1.107
= -29,280,000 + 42,384,454 + 620,921
= 13,725,375
Thus, NPV sensitivity to Price = (13,725,375-11,446,955)/(55,000-53,000) =$1,139.21
So, for every unit increase in quantity sold, the NPV increases by $1,139.21