Question

Gorilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $650 per set and have a variable cost of $320 per set. The company has spent $150,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years, where seven years is the life of the project. The marketing study also determined that the company will lose sales of 13,000 sets per year of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets per year. The cheap clubs sell for $400 and have variable costs of $180 per set. The fixed costs each year will be $7,500,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $18,200,000 and will be depreciated on a straight-line basis over the life of the project. The new clubs will also require an increase in net working capital of $950,000 that will be returned at the end of the project. The tax rate is 40 percent. Due to the extremely competitive and, therefore, risky nature of the golf club business the cost of capital is estimated to be 16 percent.

- the unit sales of the new clubs,
- the unit price of the new clubs,
- the unit variable cost of the new clubs,
- the fixed costs
- the unit sales lost of the high-priced clubs
- the unit sales gained of the cheap clubs

are only accurate to within ±10 percent.  What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing (high-priced and cheap) sets of clubs are known with certainty; only the high-priced and cheap club unit sales - gained or lost - are uncertain.  Be careful.  For example, you should realize that in a worst-case scenario, unit sales, unit price and sales gained are 10 percent lower, but fixed costs, unit costs and sales lost are 10 percent higher.  The opposite would be true in a best case scenario.  I cannot set this problem up for you any more than this. Look at the examples in your text for the correct approach.)

Answer 1

BASE CASE
	0	1	2	3	4	5	6	7
Initial Investment----a	-18200000
NWC introduced & recovered----b	-950000							950000
New clubs
S.P./set		650	650	650	650	650	650	650
Less:V.C./set		-320	-320	-320	-320	-320	-320	-320
Contn./set		330	330	330	330	330	330	330
No.of sets sold/yr.		55000	55000	55000	55000	55000	55000	55000
Total contribution/yr.----1		18150000	18150000	18150000	18150000	18150000	18150000	18150000
Lost Contn. From sales of high-priced clubs
S.P./set		1100	1100	1100	1100	1100	1100	1100
Less:V.C./set		-600	-600	-600	-600	-600	-600	-600
Contn./set		500	500	500	500	500	500	500
No.of sets sold/yr.		-13000	-13000	-13000	-13000	-13000	-13000	-13000
Total contribution Lost/yr.----2		-6500000	-6500000	-6500000	-6500000	-6500000	-6500000	-6500000
Gained Contn. From sale of cheap-priced clubs
S.P./set		400	400	400	400	400	400	400
Less:V.C./set		-180	-180	-180	-180	-180	-180	-180
Contn./set		220	220	220	220	220	220	220
No.of sets sold/yr.		10000	10000	10000	10000	10000	10000	10000
Total contribution gained/yr.----3		2200000	2200000	2200000	2200000	2200000	2200000	2200000
Less: Fixed costs/yr.----4		-7500000	-7500000	-7500000	-7500000	-7500000	-7500000	-7500000
Less: Depn./yr-----5		-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000
EBIT-----5=1+2+3+4		3750000	3750000	3750000	3750000	3750000	3750000	3750000
Less:Tax at 40%		-1500000	-1500000	-1500000	-1500000	-1500000	-1500000	-1500000
EAT		2250000	2250000	2250000	2250000	2250000	2250000	2250000
Add Back: Depn		2600000	2600000	2600000	2600000	2600000	2600000	2600000
Operating cash flow-----c		4850000	4850000	4850000	4850000	4850000	4850000	4850000
Net annual cash flow----a+b+c	-19150000	4850000	4850000	4850000	4850000	4850000	4850000	5800000
PV F at 16%	1	0.86207	0.74316	0.64066	0.55229	0.47611	0.41044	0.35383
PV at 16%	-19150000	4181034	3604340	3107190	2678612	2309148	1990645	2052211
NPV	773180
BEST CASE
	0	1	2	3	4	5	6	7
Initial Investment----a	-18200000
NWC introduced & recovered----b	-950000							950000
New clubs
S.P./set		715	715	715	715	715	715	715
Less:V.C./set		-288	-288	-288	-288	-288	-288	-288
Contn./set		427	427	427	427	427	427	427
No.of sets sold/yr.		60500	60500	60500	60500	60500	60500	60500
Total contribution/yr.----1		25833500	25833500	25833500	25833500	25833500	25833500	25833500
Lost Contn. From sales of high-priced clubs
S.P./set		1100	1100	1100	1100	1100	1100	1100
Less:V.C./set		-600	-600	-600	-600	-600	-600	-600
Contn./set		500	500	500	500	500	500	500
No.of sets sold/yr.		-11700	-11700	-11700	-11700	-11700	-11700	-11700
Total contribution Lost/yr.----2		-5850000	-5850000	-5850000	-5850000	-5850000	-5850000	-5850000
Gained Contn. From sale of cheap-priced clubs
S.P./set		400	400	400	400	400	400	400
Less:V.C./set		-180	-180	-180	-180	-180	-180	-180
Contn./set		220	220	220	220	220	220	220
No.of sets sold/yr.		11000	11000	11000	11000	11000	11000	11000
Total contribution gained/yr.----3		2420000	2420000	2420000	2420000	2420000	2420000	2420000
Less: Fixed costs/yr.----4		-6750000	-6750000	-6750000	-6750000	-6750000	-6750000	-6750000
Less: Depn./yr-----5		-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000
EBIT-----5=1+2+3+4		13053500	13053500	13053500	13053500	13053500	13053500	13053500
Less:Tax at 40%		-5221400	-5221400	-5221400	-5221400	-5221400	-5221400	-5221400
EAT		7832100	7832100	7832100	7832100	7832100	7832100	7832100
Add Back: Depn		2600000	2600000	2600000	2600000	2600000	2600000	2600000
Operating cash flow-----c		10432100	10432100	10432100	10432100	10432100	10432100	10432100
Net annual cash flow----a+b+c	-19150000	10432100	10432100	10432100	10432100	10432100	10432100	11382100
PV F at 16%	1	0.86207	0.74316	0.64066	0.55229	0.47611	0.41044	0.35383
PV at 16%	-19150000	8993190	7752750	6683405	5761556	4966859	4281775	4027323
NPV	23316857
WORST CASE
	0	1	2	3	4	5	6	7
Initial Investment----a	-18200000
NWC introduced & recovered----b	-950000							950000
New clubs
S.P./set		585	585	585	585	585	585	585
Less:V.C./set		-352	-352	-352	-352	-352	-352	-352
Contn./set		233	233	233	233	233	233	233
No.of sets sold/yr.		49500	49500	49500	49500	49500	49500	49500
Total contribution/yr.----1		11533500	11533500	11533500	11533500	11533500	11533500	11533500
Lost Contn. From sales of high-priced clubs
S.P./set		1100	1100	1100	1100	1100	1100	1100
Less:V.C./set		-600	-600	-600	-600	-600	-600	-600
Contn./set		500	500	500	500	500	500	500
No.of sets sold/yr.		-14300	-14300	-14300	-14300	-14300	-14300	-14300
Total contribution Lost/yr.----2		-7150000	-7150000	-7150000	-7150000	-7150000	-7150000	-7150000
Gained Contn. From sale of cheap-priced clubs
S.P./set		400	400	400	400	400	400	400
Less:V.C./set		-180	-180	-180	-180	-180	-180	-180
Contn./set		220	220	220	220	220	220	220
No.of sets sold/yr.		9000	9000	9000	9000	9000	9000	9000
Total contribution gained/yr.----3		1980000	1980000	1980000	1980000	1980000	1980000	1980000
Less: Fixed costs/yr.----4		-8250000	-8250000	-8250000	-8250000	-8250000	-8250000	-8250000
Less: Depn./yr-----5		-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000
EBIT-----5=1+2+3+4		-4486500	-4486500	-4486500	-4486500	-4486500	-4486500	-4486500
Less:Tax at 40%		1794600	1794600	1794600	1794600	1794600	1794600	1794600
EAT		-2691900	-2691900	-2691900	-2691900	-2691900	-2691900	-2691900
Add Back: Depn		2600000	2600000	2600000	2600000	2600000	2600000	2600000
Operating cash flow-----c		-91900	-91900	-91900	-91900	-91900	-91900	-91900
Net annual cash flow----a+b+c	-19150000	-91900	-91900	-91900	-91900	-91900	-91900	858100
PV F at 16%	1	0.86207	0.74316	0.64066	0.55229	0.47611	0.41044	0.35383
PV at 16%	-19150000	-79224.1	-68296.7	-58876.4	-50755.6	-43754.8	-37719.6	303621.1
NPV	-19185006