Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $840 per set and have a variable cost of $440 per set. The company has spent $154,000 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 9,900 sets of its high-priced clubs. The high-priced clubs sell at $1,140 and have variable costs of $740. The company will also increase sales of its cheap clubs by 11,400 sets. The cheap clubs sell for $480 and have variable costs of $250 per set. The fixed costs each year will be $9,140,000. The company has also spent $1,150,000 on research and development for the new clubs. The plant and equipment required will cost $28,980,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,340,000 that will be returned at the end of the project. The tax rate is 38 percent, and the cost of capital is 10 percent. Calculate the payback period. (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.) Payback period years Calculate the NPV. (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) NPV Calculate the IRR. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) IRR

Answer 1

• Total initial investment is in PPE & Marketing Costs, total is $29,134,000.
• Expected units to be sold for 7 years are 58,000 at price $840 which translates to $48,720,000 per year in revenues.
• Variable rate is $440 x 58000 = $25,520,000.
• Deduct variable rate from revenue to arrive at contribution.
• Now, after launching new golf club, the company expects sales of premium golf clubs to decrease by 9,900 units. Variable rate per unit is $740 & sale price is $1,140, so loss of sales amounts to (1140-740)x9900=$3,960,000.
• Similarly, after launching new golf club, the company expects sales of cheap golf clubs to increase by 11,400 units. Variable rate per unit is $250 & sale price is $480, so profit on sales amounts to (480-250)x11,400=$2,622,000.
• Fixed costs given as $9140000 throughout seven years.
• Also, as loan is taken for $1,340,000, inerest @ 10% ($134,000) is also an outflow.
• There's a cash outflow in the seventh years of $1,340,000 for WC repayment.
• Now, we have arrived at TOTAL CASH INFLOWS. (for calculating NPV)
• Deduct Depreciation & Tax to arrive at Profit After Tax (which is helpful in calculating IRR)
• Payback period is calculated where total cash outflow equal total cash inflows. Notice total outflow is $29,134,000 and inflows in year 1 + year 2 + year 3 exceeds total cash outflows. So we need to take proportionate amount from year 3 to arrive at accurate Payback period (this is detailed in below snapshot).
• For calculating IRR we need to know at what rate present values of net profit after tax equals total cash outflows. If we plug in the value of 6.1% and take present values, then present values of all future net profits come to roughly $29,135,533 which is similar to $29,134,000.

58000 58000 58000 58000 58000 58000 58000 New Golf Club Selling Price PP&E Investment Marketing Cost $840.0 -$28,980,000.0 YEAR $154,000.0 Sales of new Golf clubs Variable rate of Golf Clubs -$29,134,000.0 Contribution Margin Lost Sales [($1140-$740)x9900] Total Outflow $48,720,000.0 $48,720,000.0 -$25,520,000.0 -$25,520,000.0 $23,200,000.0 $23,200,000.0 $3,960,000.0 $3,960,000.0 $19,240,000.0 $19,240,000.0 $2,622,000.0 $2,622,000.0 $21,862,000.0 $21,862,000.0 -$9,140,000.0 $9,140,000.0 $12,722,000.0 $12,722,000.0 $48,720,000.0 $25,520,000.0 $23,200,000.0 -$3,960,000.0 $19,240,000.0 $2,622,000.0 $21,862,000.0 $9,140,000.0 $12,722,000.0 $48,720,000.0 $25,520,000.0 $23,200,000.0 -$3,960,000.0 $19,240,000.0 $2,622,000.0 $21,862,000.0 9,140,000.0 $12,722,000.0 $48,720,000.0 $25,520,000.0 $23,200,000.0 $3,960,000.0 $19,240,000.0 $2,622,000.0 $21,862,000.0 $9,140,000.0 $12,722,000.0 $48,720,000.0 $25,520,000.0 $23,200,000.0 $3,960,000.0 $19,240,000.0 $2,622,000.0 $21,862,000.0 $9,140,000.0 $12,722,000.0 $48,720,000.0 $25,520,000.0 $23,200,000.0 $3,960,000.0 $19,240,000.0 $2,622,000.0 $21,862,000.0 $9,140,000.0 $12,722,000.0 Gain Sales [($480-$250)x11400) Total Profit before Fixed Costs Fixed Costs Interest Cost on Working Capital 10% on $1,340,000 $134,000.0 $12,588,000.0 $134,000.0 $12,588,000.0 $134,000.0 $12,588,000.0 $134,000.0 $12,588,000.0 -$134,000.0 $12,588,000.0 $134,000.0 $12,588,000.0 REPAYMENT OF WC TOTAL CASH INFLOWS Depreciation $12,588,000.0 -$4,140,000.0 $8,448,000.0 -$3,210,240.0 $5,237,760.0 $12,588,000.0 $4,140,000.0 $8,448,000.0 $3,210,240.0 $5,237,760.0 $12,588,000.0 -$4,140,000.0 $8,448,000.0 $3,210,240.0 $5,237,760.0 $12,588,000.0 $4,140,000.0 $8,448,000.0 -$3,210,240.0 $5,237,760.0 $12,588,000.0 $4,140,000.0 $8,448,000.0 -$3,210,240.0 $5,237,760.0 $12,588,000.0 $4,140,000.0 $8,448,000.0 $3,210,240.0 $5,237,760.0 $134,000.0 $12,588,000.0 $1,340,000.0 $11,248,000.00 -$4,140,000.0 $8,448,000.0 $3,210,240.0 $5,237,760.0 Tax @ 38% PROFIT AFTER TAX $9,457,550.71 $8,597,773.38 $7,816,157.61 $7,105,597.83 $5,772,002.51 $60,596,024.20 NPV @ 10% on Total Cash Inflow $11,443,636.36 $10,403,305.79 Payback Period 2.3 Years Total Outflow = Total Inflow at year n 29134000 = (1x12588000)+(1x12588000)+(0.3x12588000) 0.061 6.10% $4,936,625.8 $4,652,804.7 SUM OF PRESENT VALUE AT 6.5% $29,135,533.4 IRR $4,385,301.4 $4,133,177.5 $3,895,549.0 $3,671,582.5 $3,460,492.5