Question

McGilla Golf is evaluating a new line of golf clubs. The clubs will sell for $1,000 per set and have a variable cost of $450 per set. The company has spent $157,500 for a marketing study that determined the company will sell 50,500 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,500 sets of its high-priced clubs. The high-priced clubs sell at $1,500 and have variable costs of $630. The company also will increase sales of its cheap clubs by 12,100 sets. The cheap clubs sell for $450 and have variable costs of $180 per set. The fixed costs each year will be $9,650,000. The company has also spent $1,175,000 on research and development for the new clubs. The plant and equipment required will cost $31,150,000 and will be depreciated on a straight-line basis to a zero salvage value. The new clubs also will require an increase in net working capital of $2,530,000 that will be returned at the end of the project. The tax rate is 22 percent and the cost of capital is 15 percent.

    

Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs?

Answer 1

Best Case NPV = $72,78,073.90

Worst Case NPV = $48,878.65

Calculation of Sales

For new golf clubs
Selling Price	$                       1,000.00
Variable Cost	$                          450.00
No. of sets sold per year	50500
Total Sales	$            5,05,00,000.00
Total VC	$            2,27,25,000.00
For high priced clubs
Selling Price	$                       1,500.00
Variable Cost	$                          630.00
Loss in sets sold per year	9500
Decrease in Sales	$            1,42,50,000.00
Decrease in VC	$               59,85,000.00
For cheap clubs
Selling Price	$                          450.00
Variable Cost	$                          180.00
Increase in sets sold per year	12100
Increase in Sales	$               54,45,000.00
Increase in VC	$               21,78,000.00

Given Data

Cost of Plant & Machinery	$            3,11,50,000.00
Salvage Value	0
Useful Life in years	7
Depreciation per year	$               44,50,000.00
Increase in WC	$               25,30,000.00
R&D	$               11,75,000.00
Marketing Study	$                  1,57,500.00
FC	$               96,50,000.00
Tax rate	22%
Cost of Capital	15%

Incremental Sales	$            4,16,95,000.00
Incremental VC	$            1,89,18,000.00
FC	$               96,50,000.00
Gross Profit	$            1,31,27,000.00
Depriciation	$               44,50,000.00
EBIT	$               86,77,000.00
Interest	0
PBT	$               86,77,000.00
Taxes	$               19,08,940.00
PAT	$               67,68,060.00
CFAT	$               86,88,060.00
CFAT @ +10%	$               95,56,866.00
CFAT @ -10%	$               78,19,254.00
Initial Investment	$            3,24,82,500.00

Incremental Sales = Sales due to new golf clubs + Incremental sales from cheap clubs - Decrease in sales from high end clubs

Incremental VC = VC due to new golf clubs + Incremental VC from cheap clubs - Decrease in VC from high end clubs

Depreciation per year = (Purchase Price - Salvage Value) / Useful Life

CFAT = PAT + Depreciation - Increase in WC

Initial Investment = R&D costs + Plant & Machinery + Marketing Study costs

Best case NPV if cash flows are CFAT + 10%

Worst Case NPV if cash flows are CFAT - 10%

to calculate NPV, the NPV function is used with cost of capital as the discount rate

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
	$               95,56,866.00	$    95,56,866.00	$    95,56,866.00	$ 95,56,866.00	$ 95,56,866.00	$ 95,56,866.00	$ 95,56,866.00
Best Case NPV	$               72,78,073.90
Worst Case NPV	$               78,19,254.00	$    78,19,254.00	$    78,19,254.00	$ 78,19,254.00	$ 78,19,254.00	$ 78,19,254.00	$ 78,19,254.00
	$                     48,878.65