Masters Golf Products, Ltd.
Masters Golf Products, Ltd. (Masters), is a manufacturer of golf clubs selling directly to retail outlets across Canada. With the popularity of golf increasing over the past few years, they have decided to expand their product offerings beyond the existing golf clubs they manufacture.
You are Amy Fairway, a recent BBA graduate from NAIT and you have just been given your first major project with Masters in your role as Junior Financial Analyst. Mark Bunker, CEO has asked you to analyze four potential capital investment projects that Masters is considering and provide a solid recommendation to him by the end of next week. Based on your discussions with other staff members, you know that Mark Bunker owns a significant percentage of Master’s shares and will most certainly prefer the project that generates the highest net income. As well, Mark has made it clear that he does not want to engage in a new stock issue as he does not want his earnings diluted. This worries you a little as you are quite aware that Masters currently has a heavy debt load. You breathe a little easier when your review of the files indicates that the capital budget for the upcoming year has been limited to $1,040,000. Knowing there are numerous factors to consider besides simply increasing net income, you get to work.
The following four projects (with financial analysis in the tables attached) are considered to be of equal risk:
Project Mini-Golf (Table A) is a proposal by more conservative shareholders to expand into a small scale project by adding a mini-golf course to Masters. It would be expected to generate additional annual revenue with minimal costs (maintenance and seasonal staff only).
Project Driving Range (Table B) is a proposal to add a driving range to Master’s offering. With the exponential increase in golfers and continued growth expected, this is a potential high revenue opportunity with little ongoing cost after initial investment.
Project Tee Time (Table C) is a proposal to add a high-destination golf course to Masters as part of their desire to diversify. Costs are significant particularly if a dry summer occurs and excessive watering is required. On the other hand, if it is a rainy summer, revenues may not be as significant as originally anticipated.
Project Style (Table D) is a proposal by the female shareholders to expand into the clothing business with offering of a women’s golf clothing line. This is seen as a potential blockbuster investment as there are virtually no competitors and there has been a significant increase in the number of female golfers over the past few years.
After reviewing the various projects available, you pull out your favorite Corporate Finance textbook (thankfully you did not sell it after you passed the course) and begin to review the chapter on Capital Budgeting Decision-Making. You remember learning about a number of different methods (Payback period, IRR and NPV) but cannot recall why your instructor typically used the NPV method when doing problems in class. You identify a number of questions that need to be answered as part of your submission to Mark Bunker next week.
Answer each of the following questions in your analysis:
1. Refer to Tables A – D for each of the projects. What is the total increase in after tax income for each project? Given what you know about Mark Bunker, which project do you think he will prefer?
2. Compute the payback period, internal rate of return (IRR), and net present value (NPV) of all four projects based on cash flow. Use 12 percent for the cost of capital.
3. According to the payback period, which project should you recommend to Mark Bunker?
What is the major disadvantage of using this evaluation method to make your decision?
Why would it be a preferred method in decision making amongst projects?
4. According to the IRR method, which project should be chosen?
What is the major disadvantage of using IRR when high IRR projects are selected?
What are some of the other issues to consider if using the IRR evaluation method?
Assuming there is no limit to the amount that can be spent on potential projects this year, which projects would be accepted if the IRR evaluation method is used in decision-making?
5. Using the NPV method, which project should be chosen?
How does this differ from your answer using IRR?
Assuming there is no limit to the amount that can be spent on potential projects this year, which projects would you accept if the NPV evaluation method is used for decision-making?
6. You remember using something called profitability index (PI) when you took Corporate Finance. Calculate the PI for all four projects. Which project would you choose under the PI evaluation method?
7. Which project are you most likely to recommend to Mark Bunker? Be sure to write a paragraph discussing the reasons for your recommendation.
8. Professional presentation of case analysis including appropriate references.