Reference no: EM132596025

Problem 1

Gordy's Golf has decided to sell a new line of golf clubs. The clubs will sell for $790 per set and have a variable cost of $375 per set. The company has spent $250,000 for a marketing study that determined the company will sell 88,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 9,750 sets per year of its high-priced clubs. The high-priced clubs sell at $1,350 and have variable costs of $625. The company will also increase sales of its cheap clubs by 12,000 sets per year. The cheap clubs sell for $325 and have variable costs of $125 per set. The ?xed costs each year will be $17,500,000. The company has also spent $1,800,000 on research and development for the new clubs. The plant and equipment required will cost $40,500,000 and will be depreciated using the MACRS seven-year useful life table. The new clubs will also require an increase in net working capital of $2,300,000 that will be returned at the end of the project. At the end of the projects life, the capital equipment will be sold for its book value. The tax rate is 25 percent, and the cost of capital is 18.5 percent.

1. Calculate the payback period, the NPV and the IRR.
2. Test the sensitivity of NPV and IRR to a $30 decrease in the price of the new clubs.
3. Test the sensitivity of NPV and IRR to a $25 increase in the variable cost of the new clubs.

Problem 2

Laverne Industries has a beta of 1.25. The company just paid a dividend of $.95 and the dividends are expected to grow at 4 percent. The expected return on the market is 11.5 percent and Treasury bills are yielding 3.8 percent. The most recent stock price is $81.

1. Calculate the cost of equity using the dividend growth model method
2. Calculate the cost of equity using the SML method.
3. Why do you think your estimates in (a) and (b) are so different?