Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $870 per set and have a variable cost of $470 per set. The company has spent $157,000 for a marketing study that determined the company will sell 61,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,200 sets of its high-priced clubs. The high-priced clubs sell at $1,170 and have variable costs of $770. The company will also increase sales of its cheap clubs by 11,700 sets. The cheap clubs sell for $510 and have variable costs of $265 per set. The fixed costs each year will be $9,170,000. The company has also spent $1,180,000 on research and development for the new clubs. The plant and equipment required will cost $29,190,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,370,000 that will be returned at the end of the project. The tax rate is 30 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.) (Negative amounts 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

The marketing study and the research and development are both sunk costs and should be ignored.

First of all we will calculate the sales and variable costs. Since we will lose sales of the expensive clubs and gain sales of the cheap clubs, these must be accounted for as erosion. The total sales for the new project will be

Sales
New Clubs ($870 * 61000)	53070000
Expensive clubs ($ 1170 * - 10200)	-11934000
Cheap clubs ($ 510 * 11700)	5967000
	47103000

For the variable costs, we must include the units gained or lost from the existing clubs. Note that the variable costs of the expensive clubs are an inflow. If we are not producing the sets anymore, we will save these variable costs, which is an inflow. So

Variable cost
New Clubs ($470 * 61000)	-28670000
Expensive clubs ($ 770 * 10200)	7854000
Cheap clubs ($ 265 * 11700)	-3100500
	-23916500

The pro forma income statement will be:

	Base Case	Best Case	Worst cost
Sales	47103000	51813300	42392700
Variable cost	23916500	26308150	21524850
Fixed cost	9170000	10087000	8253000
Depreciation	4170000	4170000	4170000
EBIT	9846500	11248150	8444850
Taxes	2953950	3374445	2533455
Net Income	6892550	7873705	5911395
Add- Depreciation	4170000	4170000	4170000
Cash Inflow	11062550	12043705	10081395

NPV = Present value of cash Inflow - Present value of cash outflow

NPV_{BEST CASE} = [ $12043705 * (PVIFA10%,7) + 1,370,000/1.10⁷ ] - [ 29,190,000 + 1370000]

= 63966720 -  30560000

= 33406720

NPV_{WORST CASE} = [ $10081395 * (PVIFA10%,7) + 1,370,000/1.10⁷ ] - [ 29,190,000 + 1370000]

= 53679684 -  30560000

= 23119684

	NPV
Best-case	$ 33406720
Worst-case	$ 23119684