Question

Problem 9-24 Project Analysis [LO 2]

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $731 per set and have a variable cost of $361 per set. The company has spent $151,000 for a marketing study that determined the company will sell 75,100 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,600 sets per year of its high-priced clubs. The high-priced clubs sell at $1,210 and have variable costs of $550. The company will also increase sales of its cheap clubs by 11,100 sets per year. The cheap clubs sell for $341 and have variable costs of $126 per set. The fixed costs each year will be $11,210,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $24,570,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,510,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 15 percent.

  

Calculate the payback period, the NPV, and the IRR. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16. Enter your IRR answer as a percent.)

  

Payback period		years
Net present value	$
Internal rate of return		%

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)

=75100*(731-361)-8600*(1210-550)+11100*(341-126)

=24497500

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-24570000
Initial working capital		-1510000
=Initial Investment outlay		-26080000
Profits			24497500	24497500	24497500	24497500	24497500	24497500	24497500
Fixed cost			-11210000	-11210000	-11210000	-11210000	-11210000	-11210000	-11210000
-Depreciation	Cost of equipment/no. of years		-3510000	-3510000	-3510000	-3510000	-3510000	-3510000	-3510000
=Pretax cash flows			9777500	9777500	9777500	9777500	9777500	9777500	9777500
-taxes	=(Pretax cash flows)*(1-tax)		6355375	6355375	6355375	6355375	6355375	6355375	6355375
+Depreciation			3510000	3510000	3510000	3510000	3510000	3510000	3510000
=after tax operating cash flow			9865375	9865375	9865375	9865375	9865375	9865375	9865375
reversal of working capital									1510000
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									1510000
Total Cash flow for the period		-26080000	9865375	9865375	9865375	9865375	9865375	9865375	11375375

Project
Year	Cash flow stream	Cumulative cash flow
0	-26080000	-26080000
1	9865375	-16214625
2	9865375	-6349250
3	9865375	3516125
4	9865375	13381500
5	9865375	23246875
6	9865375	33112250
7	11375375	44487625

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-(-6349250))/(3516125-(-6349250))

2.64 Years

Total Cash flow for the period		-26080000	9865375	9865375	9865375	9865375	9865375	9865375	11375375
Discount factor=	(1+discount rate)^corresponding period	1	1.15	1.3225	1.520875	1.7490063	2.0113572	2.3130608	2.66001988
Discounted CF=	Cashflow/discount factor	-26080000	8578586.957	7459640.8	6486644.2	5640560.2	4904834.9	4265073.9	4276424.806
NPV=	Sum of discounted CF=	15531765.76

Total Cash flow for the period		-26080000	9865375	9865375	9865375	9865375	9865375	9865375	11375375
Discount factor=	(1+discount rate)^corresponding period	1	1.329296541	1.7670293	2.3489059	3.1223925	4.1505856	5.5173591	7.334206331
Discounted CF=	Cashflow/discount factor	-26080000	7421500.54	5583028.5	4199987.3	3159556.3	2376863.4	1788061.1	1551002.861
NPV=	Sum of discounted CF=	2.56114E-09
IRR is discount rate at which NPV = 0 =	32.93%