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

	Normal	Upper Bound + 9%	Lower Bound - 9%
Unit Sales	22,000	23,980	20,020
Price	$860	937.4	782.6
Variable Costs	$260	283.4	236.6
Fixed Costs	$7,370,000	8,033,300	6,706,700
Sales lost (expensive)	4,000	4,360	3,640
Sales gained (cheap)	4,000	4,360	3,640
	Base Case	Best Case	Worst Case
Unit Sales	22,000	23,980	20,020
Price	$860	$937.4	$782.6
Variable Costs	$260	$236.6	$283.4
Fixed Costs	$7,370,000	$6,706,700	$8,033,300
Sales lost (expensive)	$4,000	$3,640	$4,360
Sales gained (cheap)	$4,000	4,360	3,640
Best Case
Sales
New clubs = $937.4× 23,980	$22,478,852
High-priced clubs = $1170 x -3640	-$4,258,800
Cheap clubs = $480 x 4360	$2,092,800
Total sales	$20,312,852
Variable costs
New clubs = $236.6 × 23980	$5,673,668
High-priced clubs = $610 x -3,640	-$2,220,400
Cheap clubs = $190 x 4360	$828,400
Total Variable costs	$4,281,668
Pro forma income statement
Sales	$20,312,852
Less: variable cost	-$4,281,668
Less: Fixed cost	-$6,706,700
Less: Depreciation = $18,900,000/7	-$2,700,000
EBT	$6,624,484
Taxes @ 33%	-$2,186,079.72
Net Income	$4,438,404.28
OCF = NI + Depreciation	$7,138,404.28
Initial Investment	$18,900,000
Add: working capital	$1,038,000
Total cash flow in year 0	$19,938,000
NPV	Year	Cash flow	PV @ 15%	Present Value
	0	-$19,938,000	1.0000	-$19,938,000
	1	$7,138,404.28	0.8696	$6,207,308.07
	2	$7,138,404.28	0.7561	$5,397,659.19
	3	$7,138,404.28	0.6575	$4,693,616.69
	4	$7,138,404.28	0.5718	$4,081,405.82
	5	$7,138,404.28	0.4972	$3,549,048.54
	6	$7,138,404.28	0.4323	$3,086,129.16
	7	$7,138,404.28	0.3759	$2,683,590.57
Working Capital	7	$1,038,000	0.3759	$390,222.65
		Best Case	NPV	$10,150,980.68
Worst Case
Sales
New clubs = $782.6× 20020	$15,667,652
High-priced clubs = $1170 x -4360	-$5,101,200
Cheap clubs = $480 x 3640	$1,747,200
Total sales	$12,313,652
Variable costs
New clubs = $283.4 × 20020	$5,673,668
High-priced clubs = $610 x -4360	-$2,659,600
Cheap clubs = $190 x 3640	$691,600
Total Variable costs	$3,705,668
Pro forma income statement
Sales	$12,313,652
Less: variable cost	-3705668
Less: Fixed cost	-$8,033,300
Less: Depreciation = $18,900,000/7	-$2,700,000
EBT	-$2,125,316
Taxes @ 33%	-$701,354.28
Net Income	-$1,423,961.72
OCF = NI + Depreciation	$1,276,038.28
Initial Investment	$18,900,000
Add: working capital	$1,038,000
Total cash flow in year 0	$19,938,000
NPV	Year	Cash flow	PV @ 15%	Present Value
	0	-$19,938,000	1.0000	-$19,938,000
	1	$1,276,038.28	0.8696	$1,109,598.5
	2	$1,276,038.28	0.7561	$964,868.26
	3	$1,276,038.28	0.6575	$839,015.88
	4	$1,276,038.28	0.5718	$729,579.03
	5	$1,276,038.28	0.4972	$634,416.55
	6	$1,276,038.28	0.4323	$551,666.56
	7	$1,276,038.28	0.3759	$479,710.05
Working Capital	7	$1,038,000	0.3759	$390,222.65
		Worst Case	NPV	-$14,238,922.51