Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $920 per set and have a variable cost of $451 per set. The company has spent $250,000 for a marketing study that determined the company will sell 85,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,850 sets per year of its high-priced clubs. The high-priced clubs sell at $1,350 and have variable costs of $670. The company will also increase sales of its cheap clubs by 11,300 sets per year. The cheap clubs sell for $360 and have variable costs of $156 per set. The fixed costs each year will be $14,850,000. The company has also spent $2,000,000 on research and development for the new clubs. The plant and equipment required will cost $49,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $3,875,000 that will be returned at the end of the project. The tax rate is 25 percent, and the cost of capital is 12 percent.

Calculate the payback period, the NPV, and the IRR.

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)

=85000*(920-451)-8850*(1350-670)+11300*(360-156)

=36152200

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-49200000
Initial working capital		-3875000
=Initial Investment outlay		-53075000
										100.00%
Profits			36152200	36152200	36152200	36152200	36152200	36152200	36152200
Fixed cost			-14850000	-14850000	-14850000	-14850000	-14850000	-14850000	-14850000
-Depreciation	Cost of equipment/no. of years		-7028571.43	-7028571.43	-7028571.43	-7028571	-7028571	-7028571	-7028571.43	7.451E-09	=Salvage Value
=Pretax cash flows			14273628.57	14273628.57	14273628.57	14273629	14273629	14273629	14273628.57
-taxes	=(Pretax cash flows)*(1-tax)		10705221.43	10705221.43	10705221.43	10705221	10705221	10705221	10705221.43
+Depreciation			7028571.429	7028571.429	7028571.429	7028571.4	7028571.4	7028571.4	7028571.429
=after tax operating cash flow			17733792.86	17733792.86	17733792.86	17733793	17733793	17733793	17733792.86
reversal of working capital									3875000
+Tax shield on salvage book value	=Salvage value * tax rate								1.86265E-09
=Terminal year after tax cash flows									3875000
Total Cash flow for the period		-53075000	17733792.86	17733792.86	17733792.86	17733793	17733793	17733793	21608792.86

Project
Year	Cash flow stream	Cumulative cash flow
0	-53075000	-5.3E+07
1	17733792.86	-3.5E+07
2	17733792.86	-1.8E+07
3	17733792.86	126378.6
4	17733792.86	17860171
5	17733792.86	35593964
6	17733792.86	53327757
7	21608792.86	74936550
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-(-17607414.28))/(126378.58-(-17607414.28))
2.99 Years
Project
Discount rate	0.12
Year	0	1	2	3	4	5	6	7
Cash flow stream	-53075000	17733793	17733793	17733793	17733793	17733793	17733793	21608793
Discounting factor	1	1.12	1.2544	1.404928	1.5735194	1.762342	1.973823	2.210681
Discounted cash flows project	-53075000	15833744	14137271	12622563	11270146	10062630	8984491	9774720
NPV = Sum of discounted cash flows
NPV Project =	29610566.33
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project IRR is the rate at which NPV =0 IRR 0.277654804 Year 2 3 5 6 7 Cash flow strea -53075000 1.8E+07 1.8E+07 1.8E+07 17733793 1.8E+07 1.8E+07 2.2E+07 Discounting fac 1 1.27765 1.6324 2.08565 2.664736 3.40461 4.34992 5.5577 Discounted cas -53075000 1.4E+07 1.1E+07 8502782 6654991 5208755 4076810 3888085 NPV = Sum of discounted cash flows NPV Project = 5.4948E-07 where Discounting fac(1 + IRR)^(Corresponding period in years) Discounted Cas Cash flow stream/discounting factor IRRE 27.77%