Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $700 per set and have a variable cost of $300 per set. The company has spent $140,000 for a marketing study that determined the company will sell 52,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets of its high-priced clubs. The high-priced clubs sell at $1,000 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $340 and have variable costs of $180 per set. The fixed costs each year will be $9,000,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $28,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,200,000 that will be returned at the end of the project. The tax rate is 35 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.) (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

This is all the information I was given.

Answer 1

	Base case	Best case	Worst case
Unit sales (new)	52,000	57,200	46,800
Price (new)	700	770	630
VC (new)	300	270	330
Fixed costs	90,00,000	81,00,000	99,00,000
Sales lost (expensive)	8,500	7,650	9,350
Sales gained (cheap)	10,000	11,000	9,000
Tax	35%	35%	35%
Initial investment	-2,80,00,000
Life of project	7

Best-case NPV Calculation:

	New golf clubs	High-priced clubs	Cheap clubs
Number	57,200	-7,650	11,000
Selling price/unit	770	1,000	340
Variable cost/unit	-270	-600	-180
Total Sales	4,40,44,000	-76,50,000	37,40,000
Total VC	-1,54,44,000	45,90,000	-19,80,000
Fixed cost	-81,00,000
EBITDA	1,92,00,000
Depreciation	-40,00,000.00
EBIT	1,52,00,000
Tax	-53,20,000
Net income	98,80,000
Add: depreciation	40,00,000
OCF	1,38,80,000

PV of OCF: PMT = 13,880,000, I = 11%; N = 7, solve for PV. PV = 65,405,284.15

PV of net working capital returned at the end of the project: FV = 1,200,000, I = 11%, N = 7, solve for PV. PV = 577,990.09

PV = -initial investment - increase in net working capital + PV of OCF + PV of NWC

= -28,000,000 - 1,200,000 + 65,405,284.15 + 577,990.09 = 36,783,274.25 (Best case NPV)

Worst-case NPV Calculation:

	New golf clubs	High-priced clubs	Cheap clubs
Number	46,800	-9,350	9,000
Selling price/unit	630	1,000	340
Variable cost/unit	-330	-600	-180
Total Sales	2,94,84,000	-93,50,000	30,60,000
Total VC	-1,54,44,000	56,10,000	-16,20,000
Fixed cost	-99,00,000
EBITDA	18,40,000
Depreciation	-40,00,000.00
EBIT	-21,60,000.00
Tax	7,56,000.00
Net income	-14,04,000.00
Add: depreciation	40,00,000.00
OCF	25,96,000.00

PV of OCF: PMT = 2,596,000, I = 11%; N = 7, solve for PV. PV = 12,232,861.50

PV of net working capital returned at the end of the project: FV = 1,200,000, I = 11%, N = 7, solve for PV. PV = 577,990.09

PV = -initial investment - increase in net working capital + PV of OCF + PV of NWC

= -28,000,000 - 1,200,000 + 12,232,861.50 + 577,990.09 = -16,389,148.40 (Worst case NPV)

Note: Marketing and R&D costs are sunk costs and are not to be considered in NPV calculation.