Question

Conch Republic Electronics

Conch Republic Electronics is a mid sized 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 finance department.

One of the major revenue-producing items manufactured by Conch Republic is a personal digital assistant (PDA). Conch Republic currently has one PDA model on the market, and sales have been excellent. The PDA 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 PDA has limited features in comparison with newer models. Conch Republic developed a prototype for a new PDA that has all the features of the existing PDA but adds new features such as cell phone capability. The company has performed a marketing study to determine the expected sales figures for the new PDA.

Conch Republic can manufacture the new PDA for $200 each in variable costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimated sales volume is 70,000, 80,000, 100,000, 85,000, and 75,000 per each year for the next five years, respectively. The unit price of the new PDA will be $340. The necessary equipment can be purchased for $16.5 million and will be depreciated on a 5 year straight-line schedule.

Net working capital investment for the PDAs will be $6,000,000 the first year of operations. Of course NWC will be recovered at the projects end. Conch Republic has a 35 percent corporate tax rate and a 12 percent required return.

Shelly has asked Jay to prepare a report that answers the following questions:

1. What is the IRR of the project?
2. What is the NPV of the project, based on the required rate of return of 12%?

Answer 1

Determination of Operating Cash flows:

S.No	Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
A	Sales ( Volume)	70000	80000	100000	85000	75000
B	Sale price per unit	$340	$340	$340	$340	$340
C	Sales ( A*B)	$23,800,000	$27,200,000	$34,000,000	$28,900,000	$25,500,000
D	Variable Cost per unit	$200	$200	$200	$200	$200
E	Total Variabe Cost ( A*D)	$14,000,000	$16,000,000	$20,000,000	$17,000,000	$15,000,000
F	Fixed Cost	$4,500,000	$4,500,000	$4,500,000	$4,500,000	$4,500,000
G	Depreciation	$3,300,000.00	$3,300,000.00	$3,300,000.00	$3,300,000.00	$3,300,000.00
H	Profit Before Tax ( C-E-F-G)	$2,000,000.00	$3,400,000.00	$6,200,000.00	$4,100,000.00	$2,700,000.00
I	Tax @ 35% on H	$700,000.00	$1,190,000.00	$2,170,000.00	$1,435,000.00	$945,000.00
J	Profit After Tax( H-I)	$1,300,000.00	$2,210,000.00	$4,030,000.00	$2,665,000.00	$1,755,000.00
K	Operating Cash flows( J+G)	$4,600,000.00	$5,510,000.00	$7,330,000.00	$5,965,000.00	$5,055,000.00

Depreciation =( Cost of Asset - Salvage value) / useful life

= ( $ 16500000-0) /5

= $ 3300000

Computation of Present Value of Cash inflows

Year	OCF	Disc @ 12%	Discounted Cash flows( OCF * PV factor)
1	$4,600,000.00	0.8929	$4,107,142.86
2	$5,510,000.00	0.7972	$4,392,538.27
3	$7,330,000.00	0.7118	$5,217,349.22
4	$5,965,000.00	0.6355	$3,790,865.34
5	$5,055,000.00	0.5674	$2,868,342.76
	Total		$20,376,238.43

Computation of Net Working Capital used

Year	Cash flow	Disc @ 12%	Discounted Cash flows
1	($6,000,000)	0.8929	($5,357,142.86)
2	0	0.7972	$0.00
3	0	0.7118	$0.00
4	0	0.6355	$0.00
5	$6,000,000	0.5674	$3,404,561.13
	Total		($1,952,581.72)

Computation of NPV

S.No	Particulars	Amount
A	PV of Operating Cashinflows	$20,376,238.43
B	Initial Cost	$16,500,000
C	Net Working Capital used	$1,952,581.72
D	Net Present Value ( A-B-C)	$1,923,656.71

Hence NPV of a Project is $ 1923656.71

Computation of IRR:

Year	Cash flow	Disc @ 12%	Discounting Factor	Discounted Cashflow( Cash flow* Discounting factor at 12%)	Disc @ 15%	Discounting Factor	Discounted Cashflow( Cash flow* Discounting factor at 15%)	Disc @ 16%	Discounting Factor	Discounted Cashflow( Cash flow* Discounting factor at 16%)
0	($16,500,000)	1	1	($16,500,000)	1	1	($16,500,000)	1	1	($16,500,000)
1	($6,000,000)	1/( 1.12)^1	0.8929	($5,357,143)	1/( 1.15)^1	0.8696	($5,217,391)	1/( 1.16)^1	0.8621	($5,172,414)
1	$4,600,000	1/( 1.12)^1	0.8929	$4,107,143	1/( 1.15)^1	0.8696	$4,000,000	1/( 1.16)^1	0.8621	$3,965,517
2	$5,510,000	1/( 1.12)^2	0.7972	$4,392,538	1/( 1.15)^2	0.7561	$4,166,352	1/( 1.16)^2	0.7432	$4,094,828
3	$7,330,000	1/( 1.12)^3	0.7118	$5,217,349	1/( 1.15)^3	0.6575	$4,819,594	1/( 1.16)^3	0.6407	$4,696,021
4	$5,965,000	1/( 1.12)^4	0.6355	$3,790,865	1/( 1.15)^4	0.5718	$3,410,508	1/( 1.16)^4	0.5523	$3,294,416
5	$5,055,000	1/( 1.12)^5	0.5674	$2,868,343	1/( 1.15)^5	0.4972	$2,513,228	1/( 1.16)^5	0.4761	$2,406,751
5*	$6,000,000	1/( 1.12)^5	0.5674	$3,404,400	1/( 1.15)^5	0.4972	$2,983,200	1/( 1.16)^5	0.4761	$2,856,678
		Total		$1,923,496			$175,491			($358202)

* In Year 5 , Working Capital is recovered.

We know that at IRR , NPV should be 0.

From the table we can say that IRR lies between 8% and 9%

To find the Exact rate we can use the interpolation technique.

L.R +[ { NPV at L.R * ( H.R - L.R)}/ ( NPV at L.R - NPV at H.R) ]

Here L.R = Lower rate and H.R = Higher rate

15% + [ { $ 175491( 16%-15%) }/ ( $ 175491-( -$ 358202)]

15% + [ $ 175491/ $ 533693]

15% + 0.3288%

15.33%

Hence the IRR is 15.33%

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