Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $847 per set and have a variable cost of $418 per set. The company has spent $172024 for a marketing study that determined the company will sell 5419 sets per year for seven years. The marketing study also determined that the company will lose sales of 929 sets of its high-priced clubs. The high-priced clubs sell at $1106 and have variable costs of $704. The company will also increase sales of its cheap clubs by 1013 sets. The cheap clubs sell for $470 and have variable costs of $237 per set. The fixed costs each year will be $906113. The company has also spent $102009 on research and development for the new clubs. The plant and equipment required will cost $2857433 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $132372 that will be returned at the end of the project. The tax rate is 30 percent, and the cost of capital is 11 percent. What is the sensitivity of the NPV to changes in the price of the new clubs?

Answer 1

Increased contribution from cheap clubs = (price of cheap club - variable cost) * number of clubs

Lost contribution from high-end clubs = (price of high-end club - variable cost) * number of clubs

Operating cash flow (OCF) each year = income after tax + depreciation

NPV is calculated using NPV function in Excel

The NPV when the price of new clubs is $847 is calculated to be $777,451

NPV sensitivity = change in NPV / change in price

If the price is increased by 1%, the new price is $847 + 1% = $855.47

The NPV when the price of new clubs is increased to $855.47 is calculated to be $896,198

% change in NPV = (896,198 - 777,451) / 777,451 = 15.27%

For a 1% increase in price, the NPV increases by 15.27%