| Degree of operating leverage |
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| 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 $300 per set. The company has spent $140,000 for a marketing study that determined the company will sell 52,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets of its high-priced clubs. The high-priced clubs sell at $1,000 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $340 and have variable costs of $180 per set. The fixed costs each year will be $9,000,000. The company has also spent $1,010,000 on research and development for the new clubs. The plant and equipment required will cost $28,000,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,200,000 that will be returned at the end of the project. The tax rate is 35 percent, and the cost of capital is 10 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 answers to 2 decimal places, e.g., 32.16.) |
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NPV |
| Best-case |
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| Worst-case |
$[removed] |
| McGilla Golf has decided to sell a new line of golf clubs. The company would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. The clubs will sell for $710 per set and have a variable cost of $310 per set. The company has spent $141,000 for a marketing study that determined the company will sell 53,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,600 sets of its high-priced clubs. The high-priced clubs sell at $1,010 and have variable costs of $610. The company will also increase sales of its cheap clubs by 10,100 sets. The cheap clubs sell for $350 and have variable costs of $185 per set. The fixed costs each year will be $9,010,000. The company has also spent $1,020,000 on research and development for the new clubs. The plant and equipment required will cost $28,070,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,210,000 that will be returned at the end of the project. The tax rate is 34 percent, and the cost of capital is 10 percent. What is the sensitivity of the NPV to each of these variables? (Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.) |
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NPV |
| ΔNPV/ΔP |
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| ΔNPV/ΔQ |
$ [removed] |
| Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,800,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $700,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $680,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $300 per ton. The engineering department estimates you will need an initial net working capital investment of $580,000. You require a return of 18 percent and face a marginal tax rate of 30 percent on this project. |
| a-1 |
What is the estimated OCF for this project? (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.) |
| a-2 |
What is the estimated NPV for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) |
| b. |
Suppose you believe that the accounting department’s initial cost and salvage value projections are accurate only to within ±15 percent; the marketing department’s price estimate is accurate only to within ±10 percent; and the engineering department’s net working capital estimate is accurate only to within ±5 percent. What are your worst-case and best-case NPVs for this project? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) |
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| Worst-case |
$ [removed] |
| Best-case |
$ [removed] |
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5 Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $3,000,000 investment in threading equipment to get the project started; the project will last for three years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $250 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the three-year project life. It also estimates a salvage value of $650,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $360 per ton. The engineering department estimates you will need an initial net working capital investment of $420,000. You require a return of 15 percent and face a marginal tax rate of 38 percent on this project. |
| a. |
Suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. What is the sensitivity of the project OCF to changes in the quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) |
| b. |
What is the sensitivity of NPV to changes in quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) |
| c. |
Given the sensitivity number you calculated, what is the minimum level of output below which you wouldn’t want to operate? (Do not round intermediate calculations and round your final answer to the nearest whole number, e.g., 32) |
| Minimum level of output |
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