Question

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 graduate, has been hired by the company's finance 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 figures for the new smart phone. Conch Republic can manufacture the new smart phones for $215 each in variable costs. Fixed costs for the operation are estimated to run $6.1 million per year. The estimated sales volume is 155,000, 165,000, 125,000, 95,000, and 75,000 per year for the next five years, respectively. The unit price of the new smart phone will be $520. The necessary equipment can be purchased for $40.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.1 million. Net working capital for the smart phones will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year's sales. Conch Republic has a 35 percent corporate tax rate and a required return of 12 percent. Shelley has asked Jay to prepare a report that answers the following questions.

Create Pro Forma Income Statement from YEAR 1 to 5 (Show EBITDA and EBIT).

Answer 1

1)	INCOME STATEMENT:	0	1	2	3	4	5
	New smart phone sales in units		155000	165000	125000	95000	75000
	Sales revenue (at $520)		80600000	85800000	65000000	49400000	39000000
	Variable cost (at $215)		33325000	35475000	26875000	20425000	16125000
	Fixed cost		6100000	6100000	6100000	6100000	6100000
	EBITDA		41175000	44225000	32025000	22875000	16775000
	Depreciation (MACRS)		5787450	9918450	7083450	5058450	3616650	31464450
	EBIT		35387550	34306550	24941550	17816550	13158350
	Tax at 35%		12385643	12007293	8729543	6235793	4605423
	NOPAT		23001908	22299258	16212008	11580758	8552928
	OPERATING CASH FLOW STATEMENT:
	NOPAT		23001908	22299258	16212008	11580757.5	8552927.5
	Add: Depreciation		5787450	9918450	7083450	5058450	3616650
	OCF (New smart phone)		28789358	32217708	23295458	16639208	12169578
	CHANGE IN NWC:
	NWC required (for new phone)		16120000	17160000	13000000	9880000	7800000
	Investment in NWC		16120000	1040000	-4160000	-3120000	-9880000
	Capital expenditure	40500000					-7127443	(See note below)
	FCF	-40500000	12669358	31177708	27455458	19759207.5	29177020.5
	CALCULATION OF NPV:
	FCF	-40500000	12669358	31177708	27455458	19759207.5	29177020.5
	PVIF at 12%	1	0.892857	0.7971939	0.71178	0.63551808	0.56742686
	PV at 12%	-40500000	11311926	24854678	19542252	12557333.6	16555825
	NPV	44322015
	WORKINGS:
	Loss on sale of equipment at t5:
	Book value of the equipment = 40500000-31464450 =	9035550
	Amount realized	6100000
	Loss on sale	2935550
	Tax shield on loss at 35%	1027443
	Net cash flow after tax = 6100000+1027443 =	7127443

RECOMMENDATION;

As the NPV is positive the project can be undertaken.