Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $860 per set and have a variable cost of $260 per set. The company has spent $184,000 for a marketing study that determined the company will sell 22,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 4,000 sets of its high-priced clubs. The high-priced clubs sell at $1,170 and have variable costs of $610. The company will also increase sales of its cheap clubs by 4,000 sets. The cheap clubs sell for $480 and have variable costs of $190 per set. The fixed costs each year will be $7,370,000. The company has also spent $1,105,000 on research and development for the new clubs. The plant and equipment required will cost $18,900,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,038,000 that will be returned at the end of the project. The tax rate is 33 percent, and the cost of capital is 15 percent. Assume that the values are accurate to within only ±9 percent. (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.) Required: (a) What is the best-case NPV? (Do not round your intermediate calculations.) (b) What is the worst-case NPV? (Do not round your intermediate calculations.)

Answer 1

As marketing study and research and devlopment are sunk cost they are not relevant for the project

ASSUMING INVESTMENT, WORKING CAPITAL,PRICE AND VARIABLE COST ARE CORRECT

ALSO, ASSUMING SALES OF NEW CLUBS ARE CORRECT

Cost of capital=15%

Tax rate=33%

Initial Investment=18900000

Depreciation=18900000/7=2700000

Net working capital investment=1038000

Profit of new clubs=22000*(860-260)=13200000

BEST CASE:

Loss of profits of high priced clubs=4000*(1-9%)*(1170-610)=2038400

Gain of profits of low priced clubs=4000*(1+9%)*(480-190)=1264400

Free cash flow for year 1=(13200000-2038400+12664400-2700000)*(1-33%)+2700000=16854420

NPV=-18900000-1038000+16854420/0.15*(1-1/1.15^7)+103800/1.15^7=50222483.84

WORST CASE:

Loss of profits of high priced clubs=4000*(1+9%)*(1170-610)=2441600

Gain of profits of low priced clubs=4000*(1-9%)*(480-190)=1055600

Free cash flow for year 1=(13200000-2441600+1055600-2700000)*(1-33%)+2700000=8806380

NPV=-18900000-1038000+8806380/0.15*(1-1/1.15^7)+103800/1.15^7=16739259.4