Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $805 per set and have a variable cost of $365 per set. The company has spent $220,000 for a marketing study that determined the company will sell 67,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 11,400 sets of its high-priced clubs. The high-priced clubs sell at $1,175 and have variable costs of $635. The company will also increase sales of its cheap clubs by 13,400 sets. The cheap clubs sell for $395 and have variable costs of $185 per set. The fixed costs each year will be $10,150,000. The company has also spent $1,700,000 on research and development for the new clubs. The plant and equipment required will cost $38,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $2,400,000 that will be returned at the end of the project. The tax rate is 22 percent, and the cost of capital is 10 percent.

  

a.	Calculate the payback period. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)
b.	Calculate the NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c.	Calculate the IRR. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

1]	INITIAL INVESTMENT:
	Cost of plant and equipment	$    3,80,00,000
	Increase of NWC	$        24,00,000
	Total initial investment	$    4,04,00,000
2]	Contribution margin from new clubs = (805-365)*67000 =	$    2,94,80,000
	Less: CM lost on high priced clubs = 11400*(1175-635) =	$      -61,56,000
	Add: Addl. CM on cheap clubs = 13400*(395-185) =	$        28,14,000
	Incremental contribution margin	$    2,61,38,000
	- Fixed costs	$    1,01,50,000
	- Depreciation = 38000000/7 =	$        54,28,571
	Incremental NOI	$    1,05,59,429
	Tax at 22%	$        23,23,074
	Incremental NOPAT	$        82,36,354
	+ Depreciation	$        54,28,571
	Incremental OCF	$    1,36,64,926
3]	TERMINAL NON OPERATING CASH FLOWS:
	Recovery of NWC	$        24,00,000
a]	Payback period = Initial investment/Incremental OCF = 40400000/13664926 =	2.956
b]	PV of incremental OCF = 13664926*(1.1^7-1)/(0.1*1.1^7) =	$    6,65,26,583
	PV of terminal cash flow = 2400000/1.1^7 =	$        12,31,579
	Sum of PV of cash inflows	$    6,77,58,162
	Less: Initial investment	$    4,04,00,000
	NPV	$    2,73,58,162
c]	IRR is that discount rate for which NPV = 0. It has to be found out by trial and error by trying different discount rates to get 0 NPV.
	Discounting with 30%:
	PV of incremental OCF = 13664926*(1.3^7-1)/(0.3*1.3^7) =	$    3,82,90,657
	PV of terminal cash flow = 2400000/1.3^7 =	$          3,82,479
	Sum of PV of cash inflows	$    3,86,73,136
	Less: Initial investment	$    4,04,00,000
	NPV	$      -17,26,864
	Discounting with 28%:
	PV of incremental OCF = 13664926*(1.28^7-1)/(0.28*1.28^7) =	$    4,01,34,098
	PV of terminal cash flow = 2400000/1.28^7 =	$          4,26,326
	Sum of PV of cash inflows	$    4,05,60,424
	Less: Initial investment	$    4,04,00,000
	NPV	$          1,60,424
	The discount rate [IRR] for 0 NPV lies between 30% and 28%.
	IRR by simple interpolation = 28%+2%*160424/(160424+1726864) =	28.17%