McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2800106 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. 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. 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 final answers to 2 decimal places. (e.g., 32.16)) NPV Best-case $ Worst-case $
Explanation / Answer
The best case and worst cases for the variables are:
Base Case
Best Case
Worst case
Unit Sales (new)
55,000
60,500
49,500
Price (new)
810
891
729
Variable costs (new)
410
451
369
Fixed costs
9110000
8199000
10021000
Sales lost (expensive)
9600
8640
10560
Sales gained (cheap)
11100
12210
9990
Best Case
We will calculate the sales and variable costs first. Since we will lose sales of the expensive clubsand gain sales of the cheap clubs, these must be accounted for as erosion. The total sales for thenew project will be:
Sales
New clubs $891 × 60,500 =53,905,500
Exp. Clubs $1,110 × (–8,640) = –9,590,400
Cheap clubs $450×12210 =5,494,500
49,809,600
For the variable costs, we must include the units gained or lost from the existing clubs. Note thatthe variable costs of the expensive clubs are an inflow. If we are not producing the sets anymore,we will save these variable costs, which is an inflow. So:
Var. Costs
New clubs– $451 × 60,500= –27,285,500
Exp. clubs– $710 × (–8,640)= 6,134,400
Cheap clubs– $235 × 12,210= –2,869,350
–24,020,450
The pro forma income statement will be:
Sales$49,809,600
Variable Costs 24,020,450
Fixed Costs 8,199,000
Depreciation 4,110,000
EBIT13,480,150 = Sales – (Variable Costs + Fixed Costs) – Depreciation
Taxes (40%) 5,392,060= 0.40(EBIT)
Net Income 8,088,090= EBIT – Taxes
OCF = Net Income + Depreciation = $8,088,090 + 4,110,000 = $12,198,090
NPV = –$28,770,000 – 1,310,000 + $12,198,090(PVIFA10% , 7) + 1,310,000/(1.10)7 NPV=$31,858,000.36
Worst Case
Sales
New clubs$729 × 49,500 =36,085,500
Exp. clubs$1,110 × (–10,560) = –11,721,600
Cheap clubs$450 × 9,990 =4,495,500
28,859,400
Var. Costs
New clubs–$369 × 49,500 = –18,265,500
Exp. clubs–$710 × (–10,560) = 7,497,600
Cheap clubs–$235 × 9,990 = –2,347,650
–13,115,550
The pro forma income statement will be:
Sales $28,859,400
Variable Costs 13,155,550
Fixed Costs10,021,000
Depreciation 4,110,000
EBIT=1,572,850= Sales – (Variable Costs + Fixed Costs) – Depreciation
Taxes (40%)629,140
Net Income 943,710= EBIT – TaxesOCF = NI + Depreciation = $943,710 + 4,110,000 = $5,053,710
NPV = –$28,770,000 – 1,310,000 + $5,053,710(PVIFA10%,7) + 1,310,000/(1.10)7
NPV= $2,923,699.24
Base Case
Best Case
Worst case
Unit Sales (new)
55,000
60,500
49,500
Price (new)
810
891
729
Variable costs (new)
410
451
369
Fixed costs
9110000
8199000
10021000
Sales lost (expensive)
9600
8640
10560
Sales gained (cheap)
11100
12210
9990