Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $740 per set and have a variable cost of $340 per set. The company has spent $144,000 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 8,900 sets of its high-priced clubs. The high-priced clubs sell at $1,040 and have variable costs of $640. The company will also increase sales of its cheap clubs by 10,400 sets. The cheap clubs sell for $380 and have variable costs of $200 per set. The fixed costs each year will be $9,040,000. The company has also spent $1,050,000 on research and development for the new clubs. The plant and equipment required will cost $28,280,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,240,000 that will be returned at the end of the project. The tax rate is 40 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.)

Answer 1

Best case scenario is when price, unit sales are higher by 10% and costs are lower by 10%

McGilla	0	1	2	3	4	5	6	7
Investment	-$28,280,000
NWC	-$1,240,000							$1,240,000
Sales		$50,142,400	$50,142,400	$50,142,400	$50,142,400	$50,142,400	$50,142,400	$50,142,400
VC		-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600
FC		-$8,136,000	-$8,136,000	-$8,136,000	-$8,136,000	-$8,136,000	-$8,136,000	-$8,136,000
Cannibalization		-$1,144,800	-$1,144,800	-$1,144,800	-$1,144,800	-$1,144,800	-$1,144,800	-$1,144,800
Depreciation		-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000
EBT		$17,972,000	$17,972,000	$17,972,000	$17,972,000	$17,972,000	$17,972,000	$17,972,000
Tax (40%)		-$7,188,800	-$7,188,800	-$7,188,800	-$7,188,800	-$7,188,800	-$7,188,800	-$7,188,800
Net Income		$10,783,200	$10,783,200	$10,783,200	$10,783,200	$10,783,200	$10,783,200	$10,783,200
Cash Flows	-$29,520,000	$14,823,200	$14,823,200	$14,823,200	$14,823,200	$14,823,200	$14,823,200	$16,063,200
NPV	$43,281,861.89

Worst case scenario is when price and unit sales are down 10% while costs are up 10%

McGilla	0	1	2	3	4	5	6	7
Investment	-$28,280,000
NWC	-$1,240,000							$1,240,000
Sales		$33,566,400	$33,566,400	$33,566,400	$33,566,400	$33,566,400	$33,566,400	$33,566,400
VC		-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600	-$18,849,600
FC		-$9,944,000	-$9,944,000	-$9,944,000	-$9,944,000	-$9,944,000	-$9,944,000	-$9,944,000
Cannibalization		-$2,231,200	-$2,231,200	-$2,231,200	-$2,231,200	-$2,231,200	-$2,231,200	-$2,231,200
Depreciation		-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000	-$4,040,000
EBT		-$1,498,400	-$1,498,400	-$1,498,400	-$1,498,400	-$1,498,400	-$1,498,400	-$1,498,400
Tax (40%)		$599,360	$599,360	$599,360	$599,360	$599,360	$599,360	$599,360
Net Income		-$899,040	-$899,040	-$899,040	-$899,040	-$899,040	-$899,040	-$899,040
Cash Flows	-$29,520,000	$3,140,960	$3,140,960	$3,140,960	$3,140,960	$3,140,960	$3,140,960	$4,380,960
NPV	-$13,592,175.16