Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $820 per set and have a variable cost of $420 per set. The company has spent $152,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,700 sets of its high-priced clubs. The high-priced clubs sell at $1,120 and have variable costs of $720. The company will also increase sales of its cheap clubs by 11,200 sets. The cheap clubs sell for $460 and have variable costs of $240 per set. The fixed costs each year will be $9,120,000. The company has also spent $1,130,000 on research and development for the new clubs. The plant and equipment required will cost $28,840,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,320,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 10 percent.

Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (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.) (A negative answer should be indicated by a minus sign. DO NOT ROUND INTERMEDIATE CALCULATIONS and round your answers to 2 decimal places, e.g., 32.16.)

	NPV
Best-case	$
Worst-case	$

Answer 1

	Normal	Upper Bound + 10%	Lower Bound - 10%
Unit Sales	56,000	61,600	50,400
Price	$820	$902	$738
Variable Costs	$420	$462	$378
Fixed Costs	$9,120,000	$10,032,000	$8,208,000
Sales lost (expensive)	9,700	10,670	8,730
Sales gained (cheap)	11,200	12,320	10,080
	Base Case	Best Case	Worst Case
Unit Sales	56,000	61,600	50,400
Price	$820	$902	$738
Variable Costs	$420	$378	$462
Fixed Costs	$9,120,000	$8,208,000	$10,032,000
Sales lost (expensive)	9,700	8,730	10,670
Sales gained (cheap)	11,200	12,320	10,080
Best Case
Sales
New clubs = $902× 61,600	$55,563,200
High-priced clubs = $1120 x -8730	-$9,777,600
Cheap clubs = $460 x 12320	$5,667,200
Total sales	$51,452,800
Variable costs
New clubs = $378 × 61,600	$23,284,800
High-priced clubs = $720 x -8730	-$6,285,600
Cheap clubs = $240 x 12320	$2,956,800
Total Variable costs	$19,956,000
Pro forma income statement
Sales	$51,452,800
Less: variable cost	-$19,956,000
Less: Fixed cost	-$8,208,000
Less: Depreciation = $28,840,000/7	-$4,120,000
EBT	$19,168,800
Taxes @ 35%	-$6,709,080
Net Income	$12,459,720
OCF = NI + Depreciation	$16,579,720
Initial Investment	$28,840,000
Add: working capital	$1,320,000
Total cash flow in year 0	$30,160,000
NPV	Year	Cash flow	PV @ 10%	Present Value
	0	-$30,160,000	1	-$30,160,000
	1	$16,579,720	0.909090909	$15,072,472.73
	2	$16,579,720	0.826446281	$13,702,247.93
	3	$16,579,720	0.751314801	$12,456,589.03
	4	$16,579,720	0.683013455	$11,324,171.85
	5	$16,579,720	0.620921323	$10,294,701.68
	6	$16,579,720	0.56447393	$9,358,819.71
	7	$16,579,720	0.513158118	$8,508,017.92
Working Capital	7	$1,320,000	0.513158118	$677,368.72
		Best Case	NPV	$51,234,389.56
Worst Case
Sales
New clubs = $738× 50400	$37,195,200
High-priced clubs = $1120 x -10670	-$11,950,400
Cheap clubs = $460 x 10080	$4,636,800
Total sales	$29,881,600
Variable costs
New clubs = $462 × 50400	$23,284,800
High-priced clubs = $720 x -10670	-$8,002,500
Cheap clubs = $240 x 10080	$2,570,400
Total Variable costs	$17,852,700
Pro forma income statement
Sales	$29,881,600
Less: variable cost	-17852700
Less: Fixed cost	-$10,032,000
Less: Depreciation = $28,840,000/7	-$4,120,000
EBT	-$2,123,100
Taxes @ 35%	-$743,085
Net Income	-$1,380,015
OCF = NI + Depreciation	$2,739,985
Initial Investment	$28,840,000
Add: working capital	$1,320,000
Total cash flow in year 0	$30,160,000
NPV	Year	Cash flow	PV @ 10%	Present Value
	0	-$30,160,000	1	-$30,160,000
	1	$2,739,985	0.909090909	$2,490,895.45
	2	$2,739,985	0.826446281	$2,264,450.41
	3	$2,739,985	0.751314801	$2,058,591.28
	4	$2,739,985	0.683013455	$1,871,446.62
	5	$2,739,985	0.620921323	$1,701,315.11
	6	$2,739,985	0.56447393	$1,546,650.1
	7	$2,739,985	0.513158118	$1,406,045.55
Working Capital	7	$1,320,000	0.513158118	$677,368.72
		Worst Case	NPV	-$16,143,236.75