Question

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $700 per set and have a variable cost of $340 per set. The company has spent $150,000 for a marketing study that determined the company will sell 46,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 12,000 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $550. The company will also increase sales of its cheap clubs by 20,000 sets. The cheap clubs sell for $300 and have variable costs of $100 per set. The fixed costs each year will be $8,000,000. The company also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $16,100,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $900,000 that will be returned at the end of the project. The tax rate is 40%, and the cost of capital is 14%.

1) What does McGilla Golf consider to do?

A) Increase sales

B) Add a new product

C) Remove a product

D) None of the above

2) Initial investment = $__________

3) Change in net working capital at year 0 = $__________

4) Expected total sales of the new golf club per year = $_________

5) “Relevant” sales (i.e., from the new club and the effects on high and low-priced clubs) = $__________

6) Estimated total variable costs of the new golf club per year = $__________

7) “Relevant” variable costs (i.e., from the new club and the effects on high and low-priced clubs) = $__________

8) Fixed cost per year = $__________

9) Depreciation per year = $_________

10) Operating cash flow per year = $_________

Answer 1

1)
B) Add a new product

2) Initial investment = 16100000
3) Change in net working capital at year 0 = 900000

4) Expected total sales of the new golf club per year = 700*46000=32200000

5) “Relevant” sales (i.e., from the new club and the effects on high and low-priced clubs) = 32200000-12000*1100+20000*300=25000000

6) Estimated total variable costs of the new golf club per year = 340*46000=15640000

7) “Relevant” variable costs (i.e., from the new club and the effects on high and low-priced clubs) = 15640000-12000*550+100*20000=11040000

8) Fixed cost per year = 8000000

9) Depreciation per year = 16100000/7=2300000

10) Operating cash flow per year = (25000000-11040000-8000000-2300000)*(1-40%)+2300000=4496000