Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $900 per set and have a variable cost of $300 per set. The company has spent $144,000 for a marketing study that determined the company will sell 58,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 13,000 sets of its high-priced clubs. The high-priced clubs sell at $1,400 and have variable costs of $600. The company will also increase sales of its cheap clubs by 8,000 sets. The cheap clubs sell for $500 and have variable costs of $200 per set. The fixed costs each year will be $7,200,000. The company has also spent $1,080,000 on research and development for the new clubs. The plant and equipment required will cost $18,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,037,000 that will be returned at the end of the project. The tax rate is 34 percent, and the cost of capital is 15 percent.

McGilla Golf 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 sensitivity of the NPV to changes in the price is $ and the sensitivity of the NPV to the quantity sold is $. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))

Answer 1

Answer:

The Base case NPV = $38,809,431.93

Sensitivity of NPV to changes in the price of the new clubs by 1$ = 159,260.87

Sensitivity of NPV to changes in the quantity of the new clubs by 1 unit = 1647.53

Workings:

Sales price per unit Variable cost per unit Contribution per unit New golf clubs High-priced clubs Cheap clubs 500 200 $900 $300 $600 600 $800 $300 Quantities Contribution 58000 13000 8000 $34,800,000 $10,400,000 $2,400,000

Terminal cash flow Year Plant and equipment Cost Increase in working capital Contribution - New golf club Contribution - Cheap golf club Reduction in contribution - High priced club Depreciation Fixed cost Earnings before tax Tax at 34% Earnings after tax Add back depreciation Cash flow PV factor of annuity [(1-1/ (1+ 15%)17/15%) PV factor for Terminal cash flow [1/(1+15%)17] Discounted cash flow NPV 0 1 TO 7 $18,000,000.00 ($1,037,000.00) $1,037,000.00 $34,800,000.00 $2,400,000.00 ($10,400,000.00) ($2,571,428.57 $7.200,000.00 $17,028,571.43 ($5,789,714.29) $11,238,857.14 $2,571,428.57 ($19,037,000.00)$13,810,285.71 4.1604197 $1,037,000.00 0.3759370 ($19,037,000.00)57,456,585.22 $389,846.71 $38,809,431.93

Sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold:

1.Sensitivity of NPV to changes in the price of the new clubs:

Change in NPV on change in price = (Change in contribution * Quantity) * (1 - Tax rate) * PV factor for annuity

Change in NPV on change in price by $1 = ($1 * 58000) * (1 - 34%) * 4.1604197 =159,260.87

2. Sensitivity of NPV to changes in the quantity of the new clubs:

Change in NPV on change in quantity = (Contribution per unit * Change in Quantity) * (1 - Tax rate) * PV factor for annuity

Change in NPV on change in quantity by 1 unit = ($600 * 1) * (1- 34%) * 4.1604197 = 1647.53

Hence:

Sensitivity of NPV to changes in the price of the new clubs by 1$ = 159,260.87

Sensitivity of NPV to changes in the quantity of the new clubs by 1 unit = 1647.53