Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $885 per set and have a variable cost of $423 per set. The company has spent $180,000 for a marketing study that determined the company will sell 78,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets per year of its high-priced clubs. The high-priced clubs sell at $1,315 and have variable costs of $635. The company will also increase sales of its cheap clubs by 10,600 sets per year. The cheap clubs sell for $332 and have variable costs of $135 per set. The fixed costs each year will be $14,150,000. The company has also spent $1,300,000 on research and development for the new clubs. The plant and equipment required will cost $41,500,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $3,525,000 that will be returned at the end of the project. The tax rate is 23 percent, and the cost of capital is 13 percent. Calculate the payback period, the NPV, and the IRR. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16. Enter your IRR answer as a percent.) years Payback period Net present value Internal rate of return

Answer 1

Profit=New line sales*(selling price-variable cost)-decrease in High price line sales*(selling price

-variable cost)+increase in cheap line sales*(selling price-variable cost)

=78000*(885-423)-8500*(1315-635)+10600*(332-135)

=32344200

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-41500000
Initial working capital		-3525000
=Initial Investment outlay		-45025000
Profits			32344200	32344200	32344200	32344200	32344200	32344200	32344200
Fixed cost			-14150000	-14150000	-14150000	-14150000	-14150000	-14150000	-14150000
-Depreciation	Cost of equipment/no. of years		-5928571.43	-5928571.43	-5928571.43	-5928571	-5928571	-5928571	-5928571.43
=Pretax cash flows			12265628.57	12265628.57	12265628.57	12265629	12265629	12265629	12265628.57
-taxes	=(Pretax cash flows)*(1-tax)		9444534	9444534	9444534	9444534	9444534	9444534	9444534
+Depreciation			5928571.429	5928571.429	5928571.429	5928571.4	5928571.4	5928571.4	5928571.429
=after tax operating cash flow			15373105.43	15373105.43	15373105.43	15373105	15373105	15373105	15373105.43
reversal of working capital									3525000
+Tax shield on salvage book value	=Salvage value * tax rate								1.71363E-09
=Terminal year after tax cash flows									3525000
Total Cash flow for the period		-45025000	15373105.43	15373105.43	15373105.43	15373105	15373105	15373105	18898105.43

Project
Year	Cash flow stream	Cumulative cash flow
0	-45025000	-4.5E+07
1	15373105.43	-3E+07
2	15373105.43	-1.4E+07
3	15373105.43	1094316
4	15373105.43	16467422
5	15373105.43	31840527
6	15373105.43	47213633
7	18898105.43	66111738
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-14278789.14))/(1094316.29-(-14278789.14))
2.93 Years
Project
Discount rate	0.13
Year	0	1	2	3	4	5	6	7
Cash flow stream	-45025000	15373105	15373105	15373105	15373105	15373105	15373105	18898105
Discounting factor	1	1.13	1.2769	1.442897	1.6304736	1.842435	2.081952	2.352605
Discounted cash flows project	-45025000	13604518	12039397	10654333	9428613.5	8343906	7383987	8032841
NPV = Sum of discounted cash flows
NPV Project =	24462595.23
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project
IRR is the rate at which NPV =0
IRR	0.286851435
Year	0	1	2	3	4	5	6	7
Cash flow stream	-45025000	15373105	15373105	15373105	15373105	15373105	15373105	18898105
Discounting factor	1	1.286851	1.655987	2.131009	2.7422917	3.528922	4.541198	5.843848
Discounted cash flows project	-45025000	11946294	9283351	7214004	5605933.7	4356318	3385253	3233846
NPV = Sum of discounted cash flows
NPV Project =	1.35414E-06
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	28.69%