Question

Problem 11-20 Project Analysis [LO1, 2]

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $865 per set and have a variable cost of $425 per set. The company has spent $340,000 for a marketing study that determined the company will sell 70,600 sets per year for seven years. The marketing study also determined that the company will lose sales of 13,800 sets of its high-priced clubs. The high-priced clubs sell at $1,235 and have variable costs of $695. The company will also increase sales of its cheap clubs by 15,800 sets. The cheap clubs sell for $455 and have variable costs of $245 per set. The fixed costs each year will be $10,750,000. The company has also spent $2,900,000 on research and development for the new clubs. The plant and equipment required will cost $39,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $3,600,000 that will be returned at the end of the project. The tax rate is 24 percent, and the cost of capital is 12 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.)

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)

=70600*(865-425)-13800*(1235-695)+15800*(455-245)

=26930000

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-39200000
Initial working capital		-3600000
=Initial Investment outlay		-42800000
										100.00%
Profits			26930000	26930000	26930000	26930000	26930000	26930000	26930000
Fixed cost			-10750000	-10750000	-10750000	-10750000	-10750000	-10750000	-10750000
-Depreciation	Cost of equipment/no. of years		-5600000	-5600000	-5600000	-5600000	-5600000	-5600000	-5600000	0
=Pretax cash flows			10580000	10580000	10580000	10580000	10580000	10580000	10580000
-taxes	=(Pretax cash flows)*(1-tax)		8040800	8040800	8040800	8040800	8040800	8040800	8040800
+Depreciation			5600000	5600000	5600000	5600000	5600000	5600000	5600000
=after tax operating cash flow			13640800.00	13640800.00	13640800	13640800	13640800	13640800	13640800
reversal of working capital									3600000
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									3600000
Total Cash flow for the period		-42800000	13640800	13640800	13640800	13640800	13640800	13640800	17240800

a
Project
Year	Cash flow stream	Cumulative cash flow
0	-42800000	-4.3E+07
1	13640800	-2.9E+07
2	13640800	-1.6E+07
3	13640800	-1877600
4	13640800	11763200
5	13640800	25404000
6	13640800	39044800
7	17240800	56285600
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-(-1877600))/(11763200-(-1877600))
3.14 Years
b
Project
Discount rate	0.12
Year	0	1	2	3	4	5	6	7
Cash flow stream	-4280000000.00%	13640800	13640800	13640800	13640800	13640800	13640800	17240800
Discounting factor	1	1.12	1.2544	1.404928	1.5735194	1.762342	1.973823	2.210681
Discounted cash flows project	-42800000	12179286	10874362	9709252	8668975	7740156	6910854	7798862
NPV = Sum of discounted cash flows
NPV Project =	21081747.37
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor