Question

McGilla Golf is evaluating a new line of golf clubs. The clubs will sell for $910 per set and have a variable cost of $405 per set. The company has spent $135,000 for a marketing study that determined the company will sell 46,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,600 sets of its high-priced clubs. The high-priced clubs sell at $1,410 and have variable costs of $540. The company also will increase sales of its cheap clubs by 11,200 sets. The cheap clubs sell for $405 and have variable costs of $135 per set. The fixed costs each year will be $9,200,000. The company has also spent $950,000 on research and development for the new clubs. The plant and equipment required will cost $28,000,000 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 $2,260,000 that will be returned at the end of the project. The tax rate is 23 percent and the cost of capital is 14 percent.

Calculate the payback period. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

Calculate the NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

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

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)

=46000*(910-405)-8600*(1410-540)+11200*(405-135)

=18772000

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-28000000
Initial working capital		-2260000
=Initial Investment outlay		-30260000
										100.00%
Profits			18772000	18772000	18772000	18772000	18772000	18772000	18772000
Fixed cost			-9200000	-9200000	-9200000	-9200000	-9200000	-9200000	-9200000
-Depreciation	Cost of equipment/no. of years		-4000000	-4000000	-4000000	-4000000	-4000000	-4000000	-4000000	0
=Pretax cash flows			5572000	5572000	5572000	5572000	5572000	5572000	5572000
-taxes	=(Pretax cash flows)*(1-tax)		4290440	4290440	4290440	4290440	4290440	4290440	4290440
+Depreciation			4000000	4000000	4000000	4000000	4000000	4000000	4000000
=after tax operating cash flow			8290440	8290440	8290440	8290440	8290440	8290440	8290440
reversal of working capital									2260000
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									2260000
Total Cash flow for the period		-30260000	8290440	8290440	8290440	8290440	8290440	8290440	10550440

Project
Year	Cash flow stream	Cumulative cash flow
0	-30260000	-3E+07
1	8290440	-2.2E+07
2	8290440	-1.4E+07
3	8290440	-5388680
4	8290440	2901760
5	8290440	11192200
6	8290440	19482640
7	10550440	30033080
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-(-5388680))/(2901760-(-5388680))
3.65 Years
Project
Discount rate	0
Year	0	1	2	3	4	5	6	7
Cash flow stream	-30260000	8290440	8290440	8290440	8290440	8290440	8290440	10550440
Discounting factor	1	1	1	1	1	1	1	1
Discounted cash flows project	-30260000	8290440	8290440	8290440	8290440	8290440	8290440	10550440
NPV = Sum of discounted cash flows
NPV Project =	30033080
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project
IRR is the rate at which NPV =0
IRR	20.30%
Year	0	1	2	3	4	5	6	7
Cash flow stream	-30260000	8290440	8290440	8290440	8290440	8290440	8290440	10550440
Discounting factor	1	1.202992	1.447189	1.740956	2.0943558	2.519493	3.030929	3.646182
Discounted cash flows project	-30260000	6891519	5728651	4762004	3958467.8	3290520	2735281	2893558
NPV = Sum of discounted cash flows
NPV Project =	3.46638E-05
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	20.30%