Question

Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelley Couts, who inherited the company. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. One of the major revenue-producing items manufactured by Conch Republic is a Personal Digital Assistant (PDA). Conch Republic currently has 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 ad 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 spent $750,000 to develop a prototype for a new PDA that has all the features of the existing one, but adds new features such as cell phone capability. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new PDA. Conch republic can manufacture the new PDA for $220 each in variable costs. Fixed costs for the operation are estimated to run $6.4 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 PDA will be $535. The necessary equipment can be purchased for $43.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $4.3 million. Net working capital for the PDAs will be 20% of sales and will occur with the timing of the cash flows for the year (i.e., there is no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year's sales. Conch Republic has a 21% corporate tax rate and a 12% required return. Shelly has asked Jay to prepare a report that answers the following questions. Answer the questions below and make sure to show all work that led up to your answer. Include Excel Spreadsheet. 1. What is the payback period of the project? 2. What is the profitability index of the project? 3. What is the IRR of the project? 4. What is the NPV of the project 5. How sensitive is the NPV to changes in the price of the new smartphone? 6.How sensitive is the NPV to changes in the quantity sold of the new phone?

Answer 1

		Present Value of Cash Flow;
		(Cash Flow)/((1+i)^N)
		i=discount Rate=Required rate of return=12%=0.12
		N=Year of cash Flow
		NOTE:Amount Spent in Prototype development and Marketing Study are Sunk Costs
		These costs are not Relevant for this analysis
		7 year MACRS
		Equipment Cost=$43,500,000
			A	B=A*$43,500,000	C
			Depreciation	Amount of	Accumulated
		Year	Rate	Depreciation	Depreciation
		1	0.1429	$6,216,150	$6,216,150
		2	0.2449	$10,653,150	$16,869,300
		3	0.1749	$7,608,150	$24,477,450
		4	0.1249	$5,433,150	$29,910,600
		5	0.0893	$3,884,550	$33,795,150
		Book value at end of 5 years	$9,704,850	(43500000-33795150)
		Salvage Value	$4,300,000
		Loss on Salvage	$5,404,850
		Tax Saving on loss on salvage=5404850*21%	$1,135,019
		TerminalCash Flow on Salvage	$5,435,019	(4300000+1135019)
	N	Year	0	1	2	3	4	5	6
		Investments:
	a	Equipment Installed Cost	($43,500,000)
		Operations:
	.(1)	Sales in units		155000	165000	125000	95000	75000
	.(2)	Price per unit		$535	$535	$535	$535	$535
	.(1)*(2)	Sales Revenue		$82,925,000	$88,275,000	$66,875,000	$50,825,000	$40,125,000	$0
	.(1)*$220	Variable Production Costs		-$34,100,000	-$36,300,000	-$27,500,000	-$20,900,000	-$16,500,000
		Total Fixed Costs (excluding depreciation)		($6,400,000)	($6,400,000)	($6,400,000)	($6,400,000)	($6,400,000)
		Depreciation		-$6,216,150	-$10,653,150	-$7,608,150	-$5,433,150	-$3,884,550
		Earning Before Taxes		$36,208,850	$34,921,850	$25,366,850	$18,091,850	$13,340,450
		Taxes(21%)		-$7,603,859	-$7,333,589	-$5,327,039	-$3,799,289	-$2,801,495
		Net Income/(Loss)		$28,604,992	$27,588,262	$20,039,812	$14,292,562	$10,538,956
		Add back depreciation		$6,216,150	$10,653,150	$7,608,150	$5,433,150	$3,884,550
	b	Total Operating Cash Flow		$34,821,142	$38,241,412	$27,647,962	$19,725,712	$14,423,506
		Net Working Capital(20% of Sales Revenue)		$16,585,000	$17,655,000	$13,375,000	$10,165,000	$8,025,000	$0
	3)	Working Capital Cash Flow		($16,585,000)	($1,070,000)	$4,280,000	$3,210,000	$2,140,000	$8,025,000
	4)	Cash Flow on salvage						$5,435,019
	CF=a+b+3)+4)	PROJECT NET CASH FLOW	($43,500,000)	$18,236,142	$37,171,412	$31,927,962	$22,935,712	$21,998,524	$8,025,000
		Cumulative Cash Flow	($43,500,000)	($25,263,859)	$11,907,553	$43,835,515	$66,771,226	$88,769,750	$96,794,750	SUM
	PV=CF/(1.12^N)	PRESENT VALUE OF NET CASH FLOW	($43,500,000)	$16,282,269	$29,632,822	$22,725,692	$14,576,059	$12,482,553	$4,065,715	$56,265,111
	NPV=Sumof PV	Net Present Value(NPV) of the Project	$56,265,111
		Internal Rate of Return (IRR) of the Project	54%	(Using IRR Function of excel over the Net Cash Flow)
		Payback Period=Period when Cumulative cash flow=0
		Payback Period=1+((25263859/37171412)	1.68	Years
		Profitability Index=(NPV+Initial Outlay)/(Initial Outlay)
		Profitability Index=(56265111+43500000)/43500000
		Profitability Index	2.29