Question

Conch Republic Electronics, Part 1 Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelley Couts, who inherited the company. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company’s fi nance department. One of the major revenue-producing items manufactured by Conch Republic is a smart phone. Conch Republic currently has one smart phone model on the market, and sales have been excellent. The smart phone is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smart phone that has all the features of the existing smart phone but adds new features such as WiFi tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales fi gures for the new smart phone. Conch Republic can manufacture the new smart phones for $185 each in variable costs. Fixed costs for the operation are estimated to run $5.3 million per year. The estimated sales volume is 74,000, 95,000, 125,000, 105,000, and 80,000 per year for the next fi ve years, respectively. The unit price of the new smart phone will be $480. The necessary equipment can be purchased for $38.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in fi ve years will be $5.4 million. As previously stated, Conch Republic currently manufactures a smart phone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smart phone, sales will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing smart phone is $310 per unit, with Visit us at www.mhhe.com/rwj 342 PA RT 4 Capital Budgeting variable costs of $125 each and fi xed costs of $1,800,000 per year. If Conch Republic does introduce the new smart phone, sales of the existing smart phone will fall by 15,000 units per year, and the price of the existing units will have to be lowered to $275 each. Net working capital for the smart phones will be 20 percent of sales and will occur with the timing of the cash fl ows for the year; for example, there is no initial outlay for NWC, but changes in NWC will fi rst occur in Year 1 with the fi rst year’s sales. Conch Republic has a 35 percent corporate tax rate and a 12 percent required return. Shelley has asked Jay to prepare a report that answers the following questions.

QUESTIONS 1. What is the payback period of the project? 2. What is the profi tability index of the project? 3. What is the IRR of the project? 4. What is the NPV of the project?

Need some help please.

Answer 1

CONCH REPUBLIC ELECTRONICS:
0	1	2	3	4	5
Sales in units of new smart phone		74000	95000	125000	105000	80000
Sales revenue ($480)		$   3,55,20,000	$   4,56,00,000	$ 6,00,00,000	$   5,04,00,000	$ 3,84,00,000
Variable cost ($185)		$   1,36,90,000	$   1,75,75,000	$ 2,31,25,000	$   1,94,25,000	$ 1,48,00,000
Fixed costs (other than depreciation)		$      53,00,000	$       53,00,000	$    53,00,000	$      53,00,000	$      53,00,000
Depreciation (7 Year MACRS) %		14.29	24.49	17.49	12.49	8.93	Total Depn	Book Value
Depreciation expense		$      55,01,650	$       94,28,650	$    67,33,650	$      48,08,650	$      34,38,050	$    2,99,10,650	$        85,89,350
EBIT (New smart phone)		$   1,10,28,350	$   1,32,96,350	$ 2,48,41,350	$   2,08,66,350	$ 1,48,61,950
Contribution lost on existing smart phone:
Sales in units without new phone		80000	60000
Contribution magin at $310-$125 = $185		$   1,48,00,000	$   1,11,00,000
Sales in units with new phone		65000	45000
Contribution margin at $275-$125 = $150		$      97,50,000	$       67,50,000
Loss in contribution with new phone		$      50,50,000	$       43,50,000
Incremental EBIT		$   1,60,78,350	$   1,76,46,350	$ 2,48,41,350	$   2,08,66,350	$ 1,48,61,950
Tax at 35%		$      56,27,423	$       61,76,223	$    86,94,473	$      73,03,223	$      52,01,683
NOPAT		$   1,04,50,928	$   1,14,70,128	$ 1,61,46,878	$   1,35,63,128	$      96,60,268
Add: Depreciation		$      55,01,650	$       94,28,650	$    67,33,650	$      48,08,650	$      34,38,050
OCF		$   1,59,52,578	$   2,08,98,778	$ 2,28,80,528	$   1,83,71,778	$ 1,30,98,318
Capital expenditure	$ 3,85,00,000
Change in NWC		$   71,04,000.0	$       20,16,000	$    28,80,000	$     -19,20,000	$    -24,00,000
Release of NWC						$     76,80,000
After tax salvage value = [5400000+(8589350-5400000)*35%]						$      65,16,273
After tax annual cash flows	$-3,85,00,000	$      88,48,578	$   1,88,82,778	$ 2,00,00,528	$   2,02,91,778	$ 2,96,94,590
PAYBACK PERIOD:
Cumulative after tax cash flows	$-3,85,00,000	$ -2,96,51,423	$ -1,07,68,645	$    92,31,883	$   2,95,23,660	$ 5,92,18,250
Payback period = 2+10768645/20000528 =	2.54	Years
PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
PV at 12%		$      79,00,516	$   1,50,53,235	$ 1,42,35,980	$   1,28,95,791	$ 1,68,49,508	$    6,69,35,030
PI = PV of cash inflows/Initial investment = 66935030/38500000 =	1.74
IRR:
PVIF at 34% [PVIF = 1/1.34^n]	1	0.74627	0.55692	0.41561	0.31016	0.23146
PV at 34%	$-3,85,00,000	$      66,03,416	$   1,05,16,138	$    83,12,412	$      62,93,626	$      68,73,111	$              98,702
PVIF at 35%	1	0.74074	0.54870	0.40644	0.30107	0.22301
PV at 35%	$-3,85,00,000	$      65,54,502	$   1,03,60,920	$    81,29,057	$      61,09,209	$      66,22,295	$        -7,24,017
IRR = 34%+1%*98702/(98702+724017) =	34.12%
NPV:
= PV of cash inflows-Initial investment = 66935030-38500000	$ 2,84,35,030