Question

McGilla Golkf has decided to sell a new line of golf clubs. The clubs will sell for $875 per set and have a variable cost of $430 per set. The company has spent $150,000 for a marketing study that determine the company will sell 60,000 sets per year for seven years. The marketing study also deremined that then company will lose sales of 12,000 sets of hits high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $620. The company will also increase sales of it cheap clubs by 15,000 sets. The cheap clubs sell for $400, and have variable costs of $210 per set. The fixed cost each year is $9,300,000. The company also spend $1,000,000 on R&D for the new clubs. The plant and eequitment required will cost $29,400,000 and will be depreciated on a straight-line basis over 7 years to a salvage value of $0. The new clubs will also require an increase in neot working capital of $1,400,000 that will be fully recovered at the end of the project. The tax rate is 40% and the cost of capital is 14 percent.

a) What are the incremental operating cash flows for this project?

b) What are the incremental cash flows associated with net working capital?

c) What are the incremental cash flows associated with investments?

d) What is the payback for this project?

e) What is the IRR of this project?

f) What is the NPV of this project?

Answer 1

Contribution margin on new line of golf club	selling price-variable cost per unit	875-430	445
Contribution margin on high priced golf club	selling price-variable cost per unit	1100-620	480
Contribution margin on high priced golf club	selling price-variable cost per unit	400-210	190
1-	Incremental operating cash flow
contribution margin from sale of new line of golf club	60000*445	26700000
contribution margin from increased sale of cheap club sale of golf	15000*190	2850000
decrease in contribution margin from drop in sale of high price golf club	-12000*480	-5760000
incremental contribution margin		23790000
less fixed cost		9300000
less incremental depreciation =(29400000/7)		4200000
incremental operating profit		10290000
less tax -40%		4116000
after tax incremental profit		6174000
add incremental depreciation		4200000
net operating cash flow from year 1 to 6		10374000
net operating cash flow for year 7	net operating cash flow from year 1 to 6 + recovery of working capital = 10374000+1400000	11774000
2-
incremental cash flow related to working capital at year 0		-1400000
3-
incremental cash flow related to investment		-29400000
Year	0	1	2	3	4	5	6	7
incremental cash flow related to investment	-29400000
incremental cash flow related to working capital at year 0	-1400000
net operating cash flow for year	-30800000	10374000	10374000	10374000	10374000	10374000	10374000	11774000
present value factor at 14% =1/(1+r)^n r =14%	1	0.877192982	0.769467528	0.674971516	0.592080277	0.519368664	0.455586548	0.39963732
present value of cash flow = net operating cash flow*present value factor	-30800000	9100000	7982456.14	7002154.509	6142240.797	5387930.524	4726254.846	4705329.84
net present value = sum of present value of cash flow	14246366.65
IRR = Using IRR function in MS excel	IRR(C4243:J4243)	27.89%
year	net operating cash flow for year	cumulative cash flow
0	-30800000
1	10374000	10374000
2	10374000	20748000
3	10374000	10052000	amount to be recovered in year 3
4	10374000
5	10374000
6	10374000
7	11774000
payback period = year before final year of recovery+(amount to be recovered in year 3/net operating cash flow of year 3)	2+(10052000/10374000)	2.97