Question

McGilla Golf is considering the sale of a new line of golf clubs. The clubs will sell for $900 per set and have a variable cost of $500 per set. The company has spent $159,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 11,000 sets of its high-priced clubs. The high-priced clubs sell at $1,190 and have variable costs of $790. The company will also increase sales of its cheap clubs by 11,500 sets. The cheap clubs sell for $530 and have variable costs of $275 per set. The fixed costs each year will be $9,190,000. The company has also spent $1,200,000 on research and development for the new clubs. The plant and equipment required will cost $29,330,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,390,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 12 percent.

  

Calculate the payback period. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

  

Payback period

years

  

Calculate the NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

  

Calculate the IRR. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

IRR

%

Answer 1

INITIAL INVESTMENT:
Cost of plant and equipment	29330000
Increase in NWC	1390000
Total initial outlay	30720000
OPERATING CASH FLOWS:
Contribution margin from new line of golf clubs = 55000*(900-500) =	22000000
Contribution margin lost on high priced clubs = 11000*(1190-790) =	-4400000
Addl. CM of cheap clubs = 11500*(530-275) =	2932500
Incremental contribution margin	20532500
Fixed costs	9190000
Depreciation (29330000/7)	4190000
Incremental NOI	7152500
Tax at 40%	2861000
NOPAT	4291500
Add: Depreciation	4190000
Annual operating cash flow	8481500
TERMINAL NON OPERATING CASH FLOWS:
Release of NWC	1390000
PAYBACK PERIOD:
Payback period = Initial investment/Annual OCF = 30720000/8481500 =	3.62	years
NPV:
PV of annual OCF = 8481500*(1.12^7-1)/(0.12*1.12^7) =	38707501
PV of terminal cash inflow = 1390000/1.12^7 =	628765
PV of cash inflows	39336266
Less: Initial investment	30720000
NPV	$      86,16,266
IRR:
IRR is that discount rate for which NPV is 0 or PV of cash inflows = Initial investment.
The rate has to be found out by trial and error to get 0 NPV.
Discounting with 20%,
NPV = -30720000+8481500*(1.2^7-1)/(0.2*1.2^7)+1390000/1.2^7 =	240269
Discounting with 21%,
NPV = -30720000+8481500*(1.21^7-1)/(0.21*1.21^7)+1390000/1.21^7 =	-601322
IRR lies between 20% and 21%.
By simple interpolation IRR = 20%+1%*((240269/(240269+601322)) =	20.29%