Question

McGilla Golf is evaluating selling a new line of golf clubs for five years. The clubs will generate $90,000 of annual revenue for five years with an annual variable cost of $80,000. The company has spent $31,000 for a marketing study that determined the company’s expected sales. The marketing study also determined that the company will lose sales of its high-priced clubs. The high-priced clubs will have a decrease in sales resulting in a decrease in revenue of $10,000 a year as well as a decrease in variable costs of $8,000 per year. The company will also increase sales of its cheap clubs. The cheap clubs revenue will increase by $40,000 per year and have an increase in annual variable costs of $15,000. The fixed costs each year will increase by $16,000. The company has also spent $26,000 on research and development for the new clubs. The plant and equipment required will cost $55,000 and will be depreciated on a straight-line basis over ten years or $5,500 a year. The new clubs will also require an increase in net working capital of $4,000 that will be returned at the end of the project. The plant and equipment can be sold for $11,000 at the end of five years. The tax rate is 20 percent, and the cost of capital is 14.5% percent and the company tries to achieve a three year payback period.

1. a) What is the sunk cost

2. b) What is the initial investment

3. c) What are the annual operating cash flows

4. d) What is the terminal value

5. e) Calculate the payback period, the NPV, Profit Index and the IRR, Show all work

6. f) Do you accept the project, why?

Answer 1