Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $865 per set and have a variable cost of $425 per set. The company has spent $340,000 for a marketing study that determined the company will sell 70,600 sets per year for seven years. The marketing study also determined that the company will lose sales of 13,800 sets of its high-priced clubs. The high-priced clubs sell at $1,235 and have variable costs of $695. The company will also increase sales of its cheap clubs by 15,800 sets. The cheap clubs sell for $455 and have variable costs of $245 per set. The fixed costs each year will be $10,750,000. The company has also spent $2,900,000 on research and development for the new clubs. The plant and equipment required will cost $39,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $3,600,000 that will be returned at the end of the project. The tax rate is 24 percent, and the cost of capital is 12 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.)

Answer 1

%age change			10%		10%
	Base case	Formula	Best case	Formula	Worst case
Unit sales U (new)	70,600	U*(1+10%)	77,660	U*(1-10%)	63,540
Price P (new)	865	P*(1+10%)	952	P*(1-10%)	779
VC (new)	425	VC*(1-10%)	383	VC*(1+10%)	468
Fixed costs FC	10,750,000	FC*(1-10%)	9,675,000	FC*(1+10%)	11,825,000
Sales lost E (expensive)	13,800	E*(1-10%)	12,420	E*(1+10%)	15,180
Sales gained C (cheap)	15,800	E*(1+10%)	17,380	E*(1-10%)	14,220
Tax	24%		24%		24%
Initial investment	-39,200,000
Life of project	7

Base case NPV:

Formula		New golf clubs	High-priced clubs	Cheap clubs
n	Number	70,600	-13,800	15,800
s	Selling price/unit	865	1,235	455
vc	Variable cost/unit	-425	-695	-245
(S = n*s)	Total Sales	61,069,000	-17,043,000	7,189,000
(VC = n*vc)	Total VC	-30,005,000	9,591,000	-3,871,000
FC	Fixed cost	-10,750,000
(S-VC-FC)	EBITDA	16,180,000
D	Depreciation	-5,600,000
(EBITDA - D)	EBIT	10,580,000
(EBIT*Tax rate)	Tax	-2,539,200
(NI = EBIT -Tax)	Net income	8,040,800
D	Add: depreciation	5,600,000
(NI + D)	OCF	13,640,800

Present Value (PV) calculation:

PMT (or OCF)	13,640,800
I	12%
N	7
PV (1) (Using PV function)	62,253,290.20
FV (Year 7 NWC)	3,600,000
I	12%
N	7
PV (2) (Using PV function)	16,28,457.18
PV (Initial investment + Year 0 NWC) (3)	-42,800,000
Base NPV (1+2+3)	21,081,747.37

Best-case: If sales increase by 10% percent -

Formula		New golf clubs	High-priced clubs	Cheap clubs
n	Number	77,660	-12,420	17,380
s	Selling price/unit	952	1,235	455
vc	Variable cost/unit	-383	-695	-245
(S = n*s)	Total Sales	73,893,490	-15,338,700	7,907,900
(VC = n*vc)	Total VC	-29,704,950	8,631,900	-4,258,100
FC	Fixed cost	-9,675,000
(S-VC-FC)	EBITDA	31,456,540
D	Depreciation	-5,600,000.00
(EBITDA - D)	EBIT	25,856,540
(EBIT*Tax rate)	Tax	-6,205,570
(NI = EBIT -Tax)	Net income	19,650,970
D	Add: depreciation	5,600,000
(NI + D)	OCF	25,250,970.40

Present Value (PV) calculation:

PMT (or OCF)	25,250,970.40
I	12%
N	7
PV (1) (Using PV function)	115,239,281.28
FV (Year 7 NWC)	3,600,000
I	12%
N	7
PV (2) (Using PV function)	1,628,457.18
PV (Initial investment + Year 0 NWC) (3)	-42,800,000
Best case NPV (1+2+3)	74,067,738.45

Worst-case: If sales decrease by 10% percent -

Formula		New golf clubs	High-priced clubs	Cheap clubs
n	Number	63,540	-15,180	14,220
s	Selling price/unit	779	1,235	455
vc	Variable cost/unit	-468	-695	-245
(S = n*s)	Total Sales	49,465,890	-18,747,300	6,470,100
(VC = n*vc)	Total VC	-29,704,950	10,550,100	-3,483,900
FC	Fixed cost	-11,825,000
(S-VC-FC)	EBITDA	2,724,940
D	Depreciation	-5,600,000.00
(EBITDA - D)	EBIT	-2,875,060.00
(EBIT*Tax rate)	Tax	690,014.40
(NI = EBIT -Tax)	Net income	-2,185,045.60
D	Add: depreciation	5,600,000.00
(NI + D)	OCF	3,414,954.40

Present Value (PV) calculation:

PMT (or OCF)	3,414,954.40
I	12%
N	7
PV (1) (Using PV function)	15,585,020.47
FV (Year 7 NWC)	3,600,000
I	12%
N	7
PV (2) (Using PV function)	1,628,457.18
PV (Initial investment + Year 0 NWC) (3)	-42,800,000
Worst case NPV (1+2+3)	-25,586,522.35

Summary:

NPV (Base case)	21,081,747.37
NPV (Best case)	74,067,738.45
NPV (Worst case)	-25,586,522.35