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Callaway Golf Product Launch Analysis

The FX-1 Project

Since 2005, Callaway Golf has launched a number of new successful products. It has continued to excel in technological innovation, and in February 2007 introduced yet another leap in technology with its FT-i driver. The FT-i was designed with the goal of creating the world's straightest driver and features that first completely carbon composite body, allowing for greater weight distribution to the corners of the club and thus creating more stability.

Callaway Golf is considering the introduction of a new set of irons to pair with its FT hybrid drivers. These irons, dubbed the FX-1, will provide the optimal combination of control and forgiveness for the ultimate course experience. They are designed to appeal to statement golfers, who are seeking the hottest and newest technology paired with continual performance enhancement. The hope is that these new irons will reinvigorate sales at the high end of this market. A two-month, $500,000 feasibility study has produced the following estimates:

1. Market Size, Timing and Revenue projections

The target market for these irons is upscale golfers for whom price is not a primary consideration. Callaway expects a retail price of $799.99 per set or $99.99 per iron and an average wholesale price of $80 per iron initially. Market research suggests initial sales for the new irons at 120,000 units the first year. (There is a great deal of uncertainty regarding this estimate, however, with a best case scenario of 150,000 units and a worst case of 90,000.)

As is typical for these products, sales are expected to be highest in the first year. In subsequent years, sales volumes will decline and price discounts will reduce the average selling price. For the FX-1, sales volumes are expected to decline by 25% in the second year, and fall by an additional 33% (year over year) in the third year. Sales in year 4 will represent closeouts early in the year of all remaining inventory. Average selling prices are expected to decline by $10 per iron each year.

Callaway Golf believes that the introduction of this new product will lead to additional price pressure on its existing high-end offerings. Revenues for comparable top-end irons absent the FX-1 are expected to be $3.125 million for next year; the launch of the FX-1 will lead to an average discount on these existing products of 16% (in order to maintain their projected sales volume). There will be no such impact in subsequent years as the existing irons will be phased out in any case.

2. Development and Manufacturing Cost estimates

Developing the new irons will be relatively inexpensive as existing alloy and graphite technologies will be utilized. Total design and engineering costs are expected to be $400,000.

For production purposes, new molds must be created for these irons. Total upfront cost for these molds (including an extra set for backup) is $500,000. These molds will be depreciated using a straight-line depreciation schedule in years 1 through 4 for financial reporting purposes. Once in production, manufacturing costs for these irons are expected to be $30 per iron.

3. Marketing and other Overhead

Callaway Golf plans to spend $600,000 pre-marketing these new irons prior to their official launch. Once they are being sold, selling, general, and administrative expenses are expected to be 30% of sales revenues.

4. Inventory, other Working Capital, and Taxes

Callaway Golf plans to build 75,000 units prior to the initial product launch. Production in years 1 through 3 will then be set to match demand and provide for initial inventory equal to 50% of the next year's anticipated sales plus a 25% buffer to prevent stock-outs. All remaining inventory will be sold in year 4.

Callaway Golf's customers will demand standard terms on these products, and so accounts receivable are expected to remain outstanding for an average of 90 days. Incremental profits from the sales of these irons are subject to a 38.5% marginal corporate tax rate.

1. What are the key costs and benefits of the FX-1 product?

2. What is the gross margin for the FX-1 product? How does it compare with Callaway Golf overall?

3. How would the FX-1 change Callaway Golf's earnings each year?

4. How would the FX-1 change Callaway Golf's available cash each year?

5. Does the project justify the upfront investment, and the other resources it will consume?

6. How would you determine the value of this opportunity?

7. Should Callaway Golf launch the FX-1 irons?


Solution Preview

Please see the attached files

1. What are the key costs and benefits of the FX-1 product?

The key costs are
a. Design and Engineering Costs $400,000
b. Molds 500,000
c. Pre-marketing Costs 600,000
d. Investment in Working Capital 4,650,000

The cost of feasibility study of $500,000 is a sunk cost and is not relevant.

The key benefits are
a. Callaway is able to launch a new and innovative product in the market
b. These will result in improved sales at the high end
c. The existing high end irons are to be phased out and FX-1 provides a better replacement.

2. What is the gross margin for the FX-1 product? How does it compare with Callaway Golf overall?

The selling price at ...

Solution Summary

The solution explains the capital budgeting analysis for the launch of a new product by Callaway Golf