Question

McGilla Golf is evaluating a new golf club. The clubs will sell for $930 per set and have a variable cost of $415 per set. The company has spent $140,000 for a marketing study that determined the company will sell 47,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,800 sets of its high-priced clubs. The high-priced clubs sell at $1,430 and have variable costs of $560. The company also will increase sales of its cheap clubs by 11,400 sets. The cheap clubs sell for $415 and have variable costs of $145 per set. The fixed costs each year will be $9,300,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $28,700,000 and will be depreciated on a straight-line basis to a zero salvage value. The new clubs also will also require an increase in net working capital of $2,320,000 that will be returned at the end of the project. The tax rate is 25 percent and the cost of capital is 12 percent. What is the senstivity of the NPV to changes in the price and quantity sold of the new clubs? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Calculation of net cash inflow per year-

Sale value of normal clubs	43710000
Sale value of low valued clubs	4731000
Less-Variable cost of normal clubs	19505000
Less-Variable cost of low valued clubs	1653000
Less-opportunity cost of high valued clubs	7656000
Less-Fixed cost	9300000
Less-Depreciation	4100000
Profit before tax	6227000
Tax @25%	1556750
Profit after Tax	4670250
Add-Depreciation	4100000
Net cash inflow per year	8770250

Calculation of cash outflows-

Plant and Equipment	28700000
Marketing study cost	140000
R&D cost	1000000
Working capital required	2320000
Total	32160000

PV factor = (1/1.12)^1+(1/1.12)^2....+(1/1.12)^7

= 4.5638

NPV = PV of net cash inflow - PV of cash outflow

= (8770250*4.5638 + 2320000*0.4523) - 32160000

= 41075002.95 - 32160000

= $8915002.95

Notes-

In PV of cash inflow return of working capital at year end of 7 will also be included i.e. (2320000*0.4523)