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.) (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- case A A

Answer 1

Best case: Relevant Year contribution Fixed costs Depreciatio n Depreciatio Operating cash flows PBT Tax@35% PAT 0 1 34,538,400 2 34,538,400 3 34,538,400 4| 34.538.400 5 34,538,400 34,538,400 7 34,538,400 8,244,000 8,244,000 8,244,000 8,244,000 8,244,000 8,244,000 8,244,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 22,134,400 22,134,400 22,134,400 22,134,400 22,134,400 22,134,400 22,134,400 7,747,040 14,387,360 7,747,040 14,387,360 7,747,040 14,387,360 7,747,040 14,387,360 7,747,040 14,387,360 7,747,040 | 14,387,360 7,747,040 14,387,360 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 18,547,360 18,547,360 18,547,360 18,547,360 18,547,360 18,547,360 18,547,360 Total cash NWC Investment flows PVIF@12% Present value (1,360,000) (29,120,000) (30,480,000) 1.000 $ (30,480,000.00) 18,547,360 0.893 $ 16,560,142.86 18,547,360 0.797 $ 14,785,841.84 18,547,360 0.712 $ 13,201,644.50 18,547,360 0.636 $ 11,787,182.59 18,547,360 0.567 $ 10,524,270.17 18,547,360 0.507 $ 9,396,669.79 1,360,000 19,907,360 0.452 $ 9,005,078.68 1 6 Net present value $ 54,780,830.41 Contribution from sale of golf club sales Less: Contribution from loss sale of high priced clubs Add: Contribution from increased sale of cheap clubs $ 35,112,000 $ 3,636,000 $ 3,062,400 =66000* (946-414) =9090*(1160-760) =12760*(500-260) Relevant contribution 34,538,400

Worst case: Depreciatio PAT Relevant Year contribution Fixed costs 0 1 12,533,600 10,076,000 2 12,533,600 10,076,000 3 12,533,600 10,076,000 4 12,533,600 10,076,000 5 12,533,600 10,076,000 6 12,533,600 10,076,000 7 12,533,600 10,076,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 4,160,000 Depreciatio Operating Total cash PBT Tax@35% cash flows NWC Investment flows PVIF@12% Present value |(1,360,000) (29,120,000)| (30,480,000) 1.000 $ (30,480,000.00) (1,702,400)| (595,840)|(1,106,560) 4,160,000 3,053,440 3,053,440 0.893 $ 2,726,285.71 (1,702,400)| (595,840)|(1,106,560) 4,160,000 3,053,440 3,053,440 0.797 $ 2,434,183.67 (1,702,400) (595,840) (1,106,560) 4,160,000 3,053,440 3,053,440 0.712 $ 2,173,378.28 (1,702,400)| (595,840)|(1,106,560) 4,160,000 3,053,440 3,053,440 0.636 $ 1,940,516.32 (1,702,400) (595,840) (1,106,560) 4,160,000 3,053,440 3,053,440 0.567 $ 1,732,603.86 (1,702,400)| (595,840) (1,106,560) 4,160,000 3,053,440 3,053,440 0.507 $ 1,546,967.73 (1,702,400)| (595,840)| (1,106,560) 4,160,000 3,053,440 1,360,000 4,413,440 0.452 $ 1,996,416.12 Net present value $15,929,648.30 Contribution from sale of golf club sales Less: Contribution from loss sale of high priced clubs Add: Contribution from increased sale of cheap clubs $ 14,472,000 =54000* (774-506) $ 4,444,000 =11110*(1160-760) $ 2,505,600 =10440*(500-260) Relevant contribution 12,533,600

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