McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell f
ID: 2811905 • Letter: M
Question
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $740 per set and have a variable cost of $340 per set. The company has spent $144,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,900 sets of its high-priced clubs. The high-priced clubs sell at $1,040 and have variable costs of $640. The company will also increase sales of its cheap clubs by 10,400 sets. The cheap clubs sell for $380 and have variable costs of $200 per set. The fixed costs each year will be $9,040,000 The company has also spent $1,050,000 on research and development for the new clubs. The plant and equipment required will cost $28,280,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,240,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent 0 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.) NPV Best-case Worst-caseExplanation / Answer
Step1: Computation of the Initial cash outflow for the golf clubs.We have,
Initial cash outflow = Cost of Equipment + Increase in Net Working Capital
Initital Cash Outflow = 28,280,000 + 1,240,000 = $ 29,520,000
Note: Marketing study cost and Reserch and Development cost are not included in initial cash outflow because it is not relevent cost for capital budgeting decision.
Step2: Computation of the depreciation expenses per year using straight-line method.We have,
Depreciation expenses = ( Cost of Equipment - Salvage value of Equipment) / Number of year used
Depreciation expenses per year = ( 28,280,000 - 0) / 7 = $ 4,040,000
Note: We assume that salvage value of plant and equipment is zero after seven years.
Step3: Computation of the contribution margin per set for three type of golf culb set.We have,
Step4: Computation of the present value of free cash flow after taxes of new line of golf club for the base-case, best-case and worst-case.We have,
Less: Opportunity loss for high-priced club
(400 x 8,900)
Add: Opportunity gain for Cheap club set
(10,400 x 180)
Add: Recovery of Increase in Net Working
Capital x PVIF(10%, 7 years)
( 1,240,000 x 0.5132)
Step5: Computation of the net present value(NPV) of new line of golf club for the base-case, best-case and worst-case.We have,
NPV = Total Present Value Cash Inflow - Initial Cash outflow
Initital Cash Outflow $ 29,520,000