Question

McGilla Golf has decided to sell as new line of medium-priced golf clubs. The clubs will sell for $825 per set and have a variable cost of $370 per set. The company has spent $150,000 for a marketing study that determined the company will sell 74,000 medium-priced sets per year for seven years. The fixed costs each year for the new line of clubs will be $14,350,000.

The marketing study also determined that the company will lose sales of 8,900 sets per year of its high-priced clubs. The high-priced clubs sell for $1,250 and have variable costs of $630.

The company will also increase sales of its cheap clubs by 12,000 per year. The cheap clubs sell for $375 and have variable costs of $140 per set

The company has also spent $1,000,000 on research and development for the new line of clubs. The plant and equipment will cost $25,400,000 and will be depreciated on a seven-year straight line basis. The machinery will have no salvage value after 7 years. The new clubs will also require an increase in net working capital of $3,500,000, which will be returned after the proect.. The tax rate is 40 per cent and the cost of capital is 13 percent.

a. Calculated the net cash flows for years 0 through 7.

b. Calculate the payback period.

c. Calculate the NPV.

d. Without calculating the specific numbers, will the NPV increase or decrease if the company depreciates the equipment on a 7-year MACRS schedule, rather than straight line depreciation....? Explain your answer.

Answer 1

Answer a, b and c:

a. Cash flows for years 0 through 7.

b. Payback period.

c. NPV

are calculated and given below (highlighted):

Above excel with 'show formula' is as below:

The amount spent on research and development and on marketing study are sunk costs and are not relevant for this analysis. Hence the same are not considered.

Answer d:

If the company depreciates the equipment on a 7-year MACRS schedule, rather than straight line depreciation, NPV will increase.

Explanation:

MACRS results in accelerated depreciation in initial years. This provides higher depreciation tax shield and hence higher cash flows in initial years.

Higher cash flow in initial year will have higher present values resulting in higher NPV.