Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $850 per set and have a variable cost of $410 per set. The company has spent $310,000 for a marketing study that determined the company will sell 69,700 sets per year for seven years. The marketing study also determined that the company will lose sales of 13,200 sets of its high-priced clubs. The high-priced clubs sell at $1,220 and have variable costs of $680. The company will also increase sales of its cheap clubs by 15,200 sets. The cheap clubs sell for $440 and have variable costs of $230 per set. The fixed costs each year will be $10,600,000. The company has also spent $2,600,000 on research and development for the new clubs. The plant and equipment required will cost $38,900,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $3,300,000 that will be returned at the end of the project. The tax rate is 21 percent, and the cost of capital is 9 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.)

a.Payback period:_______years

b. NPV____

c.IRR

Answer 1

Profit=New line sales*(selling price-variable cost)-decrease in High price line sales*(selling price

-variable cost)+increase in cheap line sales*(selling price-variable cost)

=69700*(850-410)-13200*(1220-680)+15200*(440-230)

=26732000

A

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-38900000
Initial working capital		-3300000
=Initial Investment outlay		-42200000
										100.00%
Profits			26732000	26732000	26732000	26732000	26732000	26732000	26732000
Fixed cost			-10600000	-10600000	-10600000	-10600000	-10600000	-10600000	-10600000
-Depreciation	Cost of equipment/no. of years		-5557142.86	-5557143	-5557143	-5557143	-5557143	-5557143	-5557142.86	0	=Salvage Value
=Pretax cash flows			10574857.14	10574857	10574857	10574857	10574857	10574857	10574857.14
-taxes	=(Pretax cash flows)*(1-tax)		8354137.143	8354137.1	8354137.1	8354137.1	8354137.1	8354137.1	8354137.143
+Depreciation			5557142.857	5557142.9	5557142.9	5557142.9	5557142.9	5557142.9	5557142.857
=after tax operating cash flow			13911280	13911280	13911280	13911280	13911280	13911280	13911280
reversal of working capital									3300000
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									3300000
Total Cash flow for the period		-42200000	13911280	13911280	13911280	13911280	13911280	13911280	17211280

Project
Year	Cash flow stream	Cumulative cash flow
0	-42200000	-4.2E+07
1	13911280	-2.8E+07
2	13911280	-1.4E+07
3	13911280	-466160
4	13911280	13445120
5	13911280	27356400
6	13911280	41267680
7	17211280	58478960
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 3 and 4
therefore by interpolation payback period = 3 + (0-(-466160))/(13445120-(-466160))
3.03 Years

B

Total Cash flow for the period		-42200000	13911280	13911280	13911280	13911280	13911280	13911280	17211280
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624	1.6771001	1.828039121
Discounted CF=	Cashflow/discount factor	-42200000	12762642.2	11708846	10742061	9855101.5	9041377.5	8294841.7	9415159.558
NPV=	Sum of discounted CF=	29620029.12

C

Total Cash flow for the period		-42200000	13911280	13911280	13911280	13911280	13911280	13911280	17211280
Discount factor=	(1+discount rate)^corresponding period	1	1.272616915	1.6195538	2.0610716	2.6229545	3.3380163	4.248016	5.40609706
Discounted CF=	Cashflow/discount factor	-42200000	10931239.28	8589575.7	6749537.6	5303668	4167529.1	3274771.1	3183679.429
NPV=	Sum of discounted CF=	0.000278389
IRR is discount rate at which NPV = 0 =	27.26%