1) McGilla Golf has decided to sell a new line of golf clubs. The clubs will sel
ID: 2806619 • Letter: 1
Question
1)
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $900 per set and have a variable cost of $500 per set. The company has spent $159,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 11,000 sets of its high-priced clubs. The high-priced clubs sell at $1,190 and have variable costs of $790. The company will also increase sales of its cheap clubs by 11,500 sets. The cheap clubs sell for $530 and have variable costs of $275 per set. The fixed costs each year will be $9,190,000. The company has also spent $1,200,000 on research and development for the new clubs. The plant and equipment required will cost $29,330,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,390,000 that will be returned at the end of the project. The tax rate is 40 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.) (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
2) we are evaluating a project that costs $1,180,000, has a ten-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 66,000 units per year. Price per unit is $45, variable cost per unit is $25, and fixed costs are $750,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.
Calculate the best-case and worst-case NPV figures. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
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.) (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
NPV Best-case $ Worst-case $Explanation / Answer
Solution 1:
Best Case
We will calculate the sales and variable costs first. Since we will lose sales of the expensive clubs and gain sales of the cheap clubs, these must be accounted for as erosion. The total sales for the new project will be:
Sales
New clubs $990 × 60,500 =59,895,000
Exp. Clubs $1,190 × (–9,900) = –11,781,000
Cheap clubs $530 × 12,650 = 6,704,500
54,818,500
For the variable costs, we must include the units gained or lost from the existing clubs. Note that the variable costs of the expensive clubs are an inflow. If we are not producing the sets anymore,we will save these variable costs, which is an inflow. So
Var. Costs
New clubs–$450× 60,500 =–27,225,000
Exp. clubs–$790 × (–9,900)= 7,821,000
Cheap clubs–$275 × 12,650=–3,478,750
-22,882,750
The pro forma income statement will be:
Sales $54,818,500
Variable Costs 22,882,750
Fixed Costs 8,271,000
Depreciation 4,190,000
EBIT 19,474,750= Sales – (Variable Costs + Fixed Costs) – Depreciation
Taxes (40%) 7,789,900= 0.40(EBIT)
Net Income 11,684,850= EBIT – Taxes
OCF = Net Income + Depreciation = $11,684,850 + 4,190,000 = $15,874,850
NPV = –$29,330,000 – 1,390,000 + $15,874,850(PVIFA12%,7) + 1,390,000/1.12^7NPV
NNPV=$42,357,715.90
Worst Case
Sales
New clubs $810 × 49,500 =40,095,000
Exp. Clubs $1,190 × (–12,100) = –14,399,000
Cheap clubs $530 × 10,350 = 5,485,500
31,181,500
For the variable costs, we must include the units gained or lost from the existing clubs.
Var. Costs
New clubs–$550× 49,500 =–27,225,000
Exp. clubs–$790 × (–12,100)= 7,821,000
Cheap clubs–$275 × 10,350=–3,478,750
-20,512,250
The pro forma income statement will be:
Sales $31,181,500
Variable Costs 20,512,250
Fixed Costs 10,109,000
Depreciation 4,190,000
EBIT -3,629,750= Sales – (Variable Costs + Fixed Costs) – Depreciation
Taxes (40%) -1,451,900= 0.40(EBIT)
Net Income -2,177,850= EBIT – Taxes
OCF = Net Income + Depreciation = -2,177,850 + 4,190,000 = $2012,150
NPV = –$29,330,000 – 1,390,000 + $2,012,150(PVIFA12%,7) + 1,390,000/1.12^7NPV
NNPV=-$20,908,271.87
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