Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $720 per set and have a variable cost of $320 per set. The company has spent $142,000 for a marketing study that determined the company will sell 54,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,700 sets of its high-priced clubs. The high-priced clubs sell at $1,020 and have variable costs of $620. The company will also increase sales of its cheap clubs by 10,200 sets. The cheap clubs sell for $360 and have variable costs of $190 per set. The fixed costs each year will be $9,020,000. The company has also spent $1,030,000 on research and development for the new clubs. The plant and equipment required will cost $28,140,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,220,000 that will be returned at the end of the project. The tax rate is 36 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.)

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Answer 1

$142,000 for a marketing study is sunk cost and is irrelevant for NPV analysis.

$1,030,000 on research and development for the new clubs is sunk cost and is irrelevant for NPV analysis.

Best case NPV

Total contribution of new line of golf clubs= (720-320)*54000= 21.6m

Lost sales of high-priced clubs= (1020-620)*(8700*0.90)= -3.132m

Increase sales of its cheap clubs= (360-190)*(10200*1.10)=1.9074m

Fixed cost= -9.02m

Depreciation=28.14/7= -4.02m

Total post tax inflow per annum= 7.3354*0.64= 4694656

Initital investment= 1.22m

PV of terminal flow of 1.22m @ 10%= 0.62m

PV of post tax inflow per annum= 22.85m

NPV= 22.85+0.62-1.22= 22.25m

Worst case NPV

Total contribution of new line of golf clubs= (720-320)*54000= 21.6m

Lost sales of high-priced clubs= (1020-620)*(8700*1.10)= -3.828m

Increase sales of its cheap clubs= (360-190)*(10200*0.90)=1.5606m

Fixed cost= -9.02m

Depreciation=28.14/7= -4.02m

Total post tax inflow per annum= 6.2926*0.64= 4.0273

Initital investment= 1.22m

PV of terminal flow @ 10%= 0.62m

PV of post tax inflow per annum= 19.61m

NPV= 19.61+0.62-1.22= 19.01m