Question

ZTX Co. has decided to sell a new line of golf clubs. The clubs will sell for $783 per set and have a variable cost of $346 per set. The company has spent $151350 for a marketing study that determined the company will sell 74456 sets per year for seven years. The marketing study also determined that the company will lose sales of 8724 sets per year of its high-priced clubs. The high-priced clubs sell at $1038 and have variable costs of $516. The company will also increase sales of its cheap clubs by 11687 sets per year. The cheap clubs sell for $354 and have variable costs of $123 per set. The fixed costs each year will be $14636747. The company has also spent $1484057 on research and development for the new clubs. The plant and equipment required will cost $29783250 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $2093952 that will be returned at the end of the project. The tax rate is 36 percent, and the cost of capital is 12 percent. Calculate the NPV for this project.

Answer 1

Following two costs are irrelevant costs and hence will not be included into capital budgeting decision:

1. The company has spent $151350 for a marketing study - sunk, not recoverable, incurred, can't be reversed
2. The company has also spent $1484057 on research and development for the new clubs - - sunk, not recoverable, incurred, can't be reversed

For everything else, please see the table below that culminates into calculation of NPV. Please pay attention to the second column that explains how each row has been calculated.

All financials below are in $. Figures in parenthesis mean negative figures.

Year, N	Linkage	0	1	2	3	4	5	6	7
Purchase cost for equipment	A	(29,783,250)
Contribution from new line of golf clubs	B = (783-346) x 74,456		32,537,272	32,537,272	32,537,272	32,537,272	32,537,272	32,537,272	32,537,272
Contribution loss from high priced clubs	C = -(1038-516) x 8,724		(4,553,928)	(4,553,928)	(4,553,928)	(4,553,928)	(4,553,928)	(4,553,928)	(4,553,928)
Incremental contribution from cheap clubs	D = (354-123) x 11,687		2,699,697	2,699,697	2,699,697	2,699,697	2,699,697	2,699,697	2,699,697
Fixed costs	E		(14,636,747)	(14,636,747)	(14,636,747)	(14,636,747)	(14,636,747)	(14,636,747)	(14,636,747)
Annual Depreciation	F = A / 7		(4,254,750)	(4,254,750)	(4,254,750)	(4,254,750)	(4,254,750)	(4,254,750)	(4,254,750)
Operating income	G = sum of all the line items above		11,791,544	11,791,544	11,791,544	11,791,544	11,791,544	11,791,544	11,791,544
Taxes	H = 36% x G		(4,244,956)	(4,244,956)	(4,244,956)	(4,244,956)	(4,244,956)	(4,244,956)	(4,244,956)
NOPAT	I = G - H		7,546,588	7,546,588	7,546,588	7,546,588	7,546,588	7,546,588	7,546,588
Add back depreciation	F		4,254,750	4,254,750	4,254,750	4,254,750	4,254,750	4,254,750	4,254,750
Investment in working capital	J	(2,093,952)	-	-	-	-	-	-	2,093,952
Free Cash flows of the project	K = A + I + F + J	(31,877,202)	11,801,338	11,801,338	11,801,338	11,801,338	11,801,338	11,801,338	13,895,290
Discount rate	R	12%
Discount factor	DF = (1 + R)-N	1.0000	0.8929	0.7972	0.7118	0.6355	0.5674	0.5066	0.4523
PV of cash flows	PV = K x DF	(31,877,202)	10,536,909	9,407,955	8,399,959	7,499,964	6,696,396	5,978,925	6,285,524
NPV	Sum of all PV	22,928,430