Question

Primrose has decided to sell a new line of golf clubs. The clubs will sell for $825 per set and have a variable cost of $370 per set. The company has spent $150,000 for a marketing study that determined the company will sell 74,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,900 sets per year of its high-priced clubs. The high-priced clubs sell for $1,250 and have variable costs of $630. The company will also increase sales of its cheap clubs by 11,000 sets per year. The cheap clubs sell for $375 and have variable costs of $140 per set. The fixed costs each year will be $14,350,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $29,400,000 and will be depreciated on a straight-line basis to zero (no salvage value). The new clubs will also require an increase in net working capital of $3,500,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 14 percent. The initial cost is the equipment plus the net working capital, so: Initial cost = $32,900,000 = $29,400,000 + 3,500,000

1. Calculate Net Present Value. Would you accept or reject the project?

Answer 1

Initial cost		=	Cost of equipment+working capital
		=	$29,400,000+$3,500,000
		=	$             32,900,000.00
Depreciation		=	Cost of equipment/life
		=	$29,400,000/7
		=	$               4,200,000.00
Terminal cashflow		=	Realized working capital
		=	$$3,500,000
Calculation of margin from various porducts
			New line clubs	High priced clubs	Cheap clubs
	(a)	Sale price	$825	$1,250	$375
	(b)	Var cost	$370	$630	$140
	(.c)=a-b	Margin per unit	$455	$620	$235
	(d)	No. of units	74000	8900	11000
	(e.)=c*d	Total margin	$33,670,000	$5,518,000	$2,585,000
	Calculation of operating cashflow
		Total margin from new clubs		=	$33,670,000
		Add:Total margin from Cheap clubs		=	$2,585,000
		less:Total margin fromhigh priced clubs		=	($5,518,000)
		Less:fixed cost		=	($14,350,000)
		Less:depreciation		=	($4,200,000)
		Gross profit		=	$12,187,000
		Less: tax @40%		=	($4,874,800)
		Net profit		=	$7,312,200
		Add:Depreciation		=	$4,200,000
		Operating Cashflow		=	$11,512,200
	Present value of cashflow = PVAF(rate,time)*operatingcashflow+PVF(rate,time)*Terminal cashflow
	Present value of cash inflow		=	PVAF(14%,7)*$11,512,200 + PVF(14%,7)*$3,500,000
			=	4.2883*$11,512,000 +0.3996*$3,500,000
			=	$49,367,823+$1,398,731
			=	$50,766,554
		NPV	=	PV of cash inflow - Initial cost
			=	$50,766,554- $32,900,000
			=	$   17,866,554.00
	Since NPV is positive,we should accept the project.
	Research and market study cost are sunk cost.They do not have impact on our decision now.Hence they are ignored
	If you have any doubt,please ask
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