Question

20. Project Analysis. McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $845 per set and have a variable cost of $405 per set. The company has spent $150,000 for a marketing study that determined the company will sell 60,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,000 sets of its high-priced clubs. The high- priced clubs sell at $1,175 and have variable costs of $620. The company will also increase sales of its cheap clubs by 12,000 sets. The cheap clubs sell for $435 and have variable costs of $200 per set. The fixed costs each year will be $9.75 million. The company has also spent $1 million on research and development for the new clubs. The plan and equipment required will cost $37.1 million and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1.7 million that will be returned at the end of the project. The tax rate is 25 percent, and the cost of capital if 10 percent. Calculate the payback period, the NPV, and the IRR.

21. Sensitivity Analysis. In the previous problem, you feel that the values are accurate to within +/ 10 percent. What are the best-case and worst-case NPVs? Hint: The price and variable costs for the two existing sets of clubs are known with certainty only the sales gained or lost are uncertain.

Answer 1

Information provided:

%age change		10%	10%
	Base case	Best case	Worst case
Unit sales (new)	60,000	66,000	54,000
Price (new)	845	930	761
VC (new)	405	365	446
Fixed costs	10,400,000	9,360,000	11,440,000
Sales lost (expensive)	10,000	9,000	11,000
Sales gained (cheap)	12,000	13,200	10,800
Tax	25%	25%	25%
Initial investment	-37,100,000
Life of project	7

20).

Formula		New golf clubs	High-priced clubs	Cheap clubs
N	Number	60,000	-10,000	12,000
sp	Selling price/unit	845	1,175	435
vc	Variable cost/unit	-405	-620	-200
S = N*sp	Total Sales	50,700,000	-11,750,000	5,220,000
VC = N*vc	Total VC	-24,300,000	6,200,000	-2,400,000
FC	Fixed cost	-9,750,000
S-FC-VC	EBITDA	13,920,000
D	Depreciation	-5,300,000
EBITDA-D	EBIT	8,620,000
T = 21%*EBIT	Tax	-2,155,000
NI = EBIT-T	Net income	6,465,000
	Add: depreciation	5,300,000
NI + D	OCF	11,765,000

Initial cost = initial investment + working capital investment = -37,100,000 -1,700,000 = -38,800,000

Present Value (PV) of OCF: PMT = 11,765,000; N = 7; rate = 10%, CPT PV.

PV = 57,276,947.39

PV of return of NWC at the end of year 7 = 1,700,000/(1+10%)^7 = 872,368.80

Total NPV = -38,800,000 + 57,276,947.39 + 872,368.80 = 19,349,316.19 (Base-case NPV)

21). Best-case NPV:

Formula		New golf clubs	High-priced clubs	Cheap clubs
N	Number	66,000	-9,000	13,200
sp	Selling price/unit	930	1,175	435
vc	Variable cost/unit	-365	-620	-200
S = N*sp	Total Sales	61,347,000	-10,575,000	5,742,000
VC = N*vc	Total VC	-24,057,000	5,580,000	-2,640,000
FC	Fixed cost	-9,360,000
S-FC-VC	EBITDA	26,037,000
D	Depreciation	-5,300,000
EBITDA-D	EBIT	20,737,000
T = 21%*EBIT	Tax	-5,184,250
NI = EBIT-T	Net income	15,552,750
	Add: depreciation	5,300,000
NI + D	OCF	20,852,750

Initial cost = initial investment + working capital investment = -37,100,000 -1,700,000 = -38,800,000

Present Value (PV) of OCF: PMT = 20,852,750; N = 7; rate = 10%, CPT PV.

PV = 101,519,920.50

PV of return of NWC at the end of year 7 = 1,700,000/(1+10%)^7 = 872,368.80

Total NPV = -38,800,000 + 101,519,920.50 + 872,368.80 = 63,592,289.30 (Best-case NPV)

Worst-case NPV:

Formula		New golf clubs	High-priced clubs	Cheap clubs
N	Number	54,000	-11,000	10,800
sp	Selling price/unit	761	1,175	435
vc	Variable cost/unit	-446	-620	-200
S = N*sp	Total Sales	41,067,000	-12,925,000	4,698,000
VC = N*vc	Total VC	-24,057,000	6,820,000	-2,160,000
FC	Fixed cost	-11,440,000
S-FC-VC	EBITDA	2,003,000
D	Depreciation	-5,300,000.00
EBITDA-D	EBIT	-3,297,000.00
T = 21%*EBIT	Tax	824,250.00
NI = EBIT-T	Net income	-2,472,750.00
	Add: depreciation	5,300,000.00
NI + D	OCF	2,827,250

Initial cost = initial investment + working capital investment = -37,100,000 -1,700,000 = -38,800,000

Present Value (PV) of OCF: PMT = 2,827,250; N = 7; rate = 10%, CPT PV.

PV = 13,764,237.10

PV of return of NWC at the end of year 7 = 1,700,000/(1+10%)^7 = 872,368.80

Total NPV = -38,800,000 + 13,764,237.10 + 872,368.80 = -24,163,394.10