Question

McGilla Golf is evaluating a new line of golf clubs. The clubs will sell for $1,010 per set and have a variable cost of $455 per set. The company has spent $160,000 for a marketing study that determined the company will sell 51,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,600 sets of its high-priced clubs. The high-priced clubs sell at $1,510 and have variable costs of $640. The company also will increase sales of its cheap clubs by 12,200 sets. The cheap clubs sell for $455 and have variable costs of $185 per set. The fixed costs each year will be $9,700,000. The company has also spent $1,200,000 on research and development for the new clubs. The plant and equipment required will cost $31,500,000 and will be depreciated on a straight-line basis to a zero salvage value. The new clubs also will require an increase in net working capital of $2,560,000 that will be returned at the end of the project. The tax rate is 23 percent and the cost of capital is 12 percent.

  

Calculate the payback period. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

Calculate the NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Calculate the IRR. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Profit=New line sales*(selling price-variable cost)-decrease in High price line sales*(selling price

-variable cost)+increase in cheap line sales*(selling price-variable cost)

=51000*(1010-455)-9600*(1510-640)+12200*(455-185)

=23247000

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-31500000
Initial working capital		-2560000
=Initial Investment outlay		-34060000
Profits			23247000	23247000	23247000	23247000	23247000	23247000	23247000
Fixed cost			-9700000	-9700000	-9700000	-9700000	-9700000	-9700000	-9700000
-Depreciation	Cost of equipment/no. of years		-4500000	-4500000	-4500000	-4500000	-4500000	-4500000	-4500000
=Pretax cash flows			9047000	9047000	9047000	9047000	9047000	9047000	9047000
-taxes	=(Pretax cash flows)*(1-tax)		6966190	6966190	6966190	6966190	6966190	6966190	6966190
+Depreciation			4500000	4500000	4500000	4500000	4500000	4500000	4500000
=after tax operating cash flow			11466190	11466190	11466190	11466190	11466190	11466190	11466190
reversal of working capital									2560000
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									2560000
Total Cash flow for the period		-34060000	11466190	11466190	11466190	11466190	11466190	11466190	14026190

Year	Cash flow stream	Cumulative cash flow
0	-34060000	-34060000
1	11466190	-22593810
2	11466190	-11127620
3	11466190	338570
4	11466190	11804760
5	11466190	23270950
6	11466190	34737140
7	14026190	48763330

Payback period is the time by which undiscounted cashflow cover the intial investment outlay

this is happening between year 2 and 3

therefore by interpolation payback period = 2 + (0-(-11127620))/(338570-(-11127620))

2.97 Years

Total Cash flow for the period		-34060000	11466190	11466190	11466190	11466190	11466190	11466190	14026190
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.5735194	1.7623417	1.9738227	2.210681407
Discounted CF=	Cashflow/discount factor	-34060000	10237669.64	9140776.5	8161407.6	7286971	6506224.1	5809128.7	6344736.041
NPV=	Sum of discounted CF=	19426913.58

Total Cash flow for the period		-34060000	11466190	11466190	11466190	11466190	11466190	11466190	14026190
Discount factor=	(1+discount rate)^corresponding period	1	1.280858657	1.6405989	2.1013753	2.6915648	3.447514	4.4157782	5.655987696
Discounted CF=	Cashflow/discount factor	-34060000	8951955.733	6989027	5456517	4260046.1	3325929.9	2596640.9	2479883.4
NPV=	Sum of discounted CF=	-6.51926E-09
IRR is discount rate at which NPV = 0 =	28.09%