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 applia nces. The company is entirely equity financed, with 9 million shares of common stock outstanding. The stock currently trades at $42.50 per share. 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 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 $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 five 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 five 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 variable costs of $125 each and fixed 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 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 12 percent required return. Company can obtain a debt by issuing bond carrying coupon rate of 8%. It is established at debt equity ratio can be 70:30. Beyond this financial distress risk will arise. Shelley has asked Jay to prepare a report that answers the following questions. QUESTIONS – Capital budgeting 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? o How sensitive is the NPV to changes in the price of the new smart phone? o How sensitive is the NPV to changes in the quantity sold of the new smart phone? QUESTIONS – Capital Structure 5. What is market value of firm before undertaking project 6. Company intend to use equity only to finance the project o Calculate companies market value after it announces that the firm will finance the project using equity. o What would be the new price per share of the firm’s stock? o How many shares need to be issued to finance the purchase? o Please explain hypothesis used. 7. Suppose the company decides to issue debt to finance the purchase. o What will the market value of the Company be if the purchase is financed with debt? o What will be the new Required return on equity ? o Construct Company’s market value balance sheet after both the debt issue and the land purchase. o What is the price per share of the firm’s stock? 8. Does financing with debt affect projects NPV? 9. Which method of financing maximizes the per-share stock price of Company’s equity? And how. 10. What would be risks of having a higher Debt equity ratio of assuming 80:20? Would it impact WACC ? Assignment need to be in 2000-2500 words you need to write you reasoning for answers. Just answers will not be sufficient

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($750000) and Marketing Study($200000) are Sunk Costs
		These costs are not Relevant for this analysis
		Impact on existing Product
		Year	1	2
		If Project is not Undertaken:
	x	Sales in units	80000	60000
	y=x*(310-125)	Contribution	$14,800,000	$11,100,000
		If Project is Undertaken:
	x1	Sales in units	65000	45000
	y1=x1*(275-125)	Contribution	$9,750,000	$6,750,000
	y1-y	Before Tax Cash Flow	-$5,050,000	-$4,350,000
	z=(y1-y)*(1-0.35)	After Tax Cash Flow	-$3,282,500	-$2,827,500
		7 year MACRS
		Equipment Cost=$38,500,000
			A	B=A*$38,500,000	C
			Depreciation	Amount of	Accumulated
		Year	Rate	Depreciation	Depreciation
		1	0.1429	$5,501,650	$5,501,650
		2	0.2449	$9,428,650	$14,930,300
		3	0.1749	$6,733,650	$21,663,950
		4	0.1249	$4,808,650	$26,472,600
		5	0.0893	$3,438,050	$29,910,650
		Book value at end of 5 years	$8,589,350	(38500000-29910650)
		Salvage Value	$5,400,000
		Loss on Salvage	$3,189,350
		Tax Saving on loss on salvage=3189350*35%	$1,116,273
		TerminalCash Flow on Salvage	$6,516,273	(5400000+1116273)
	N	Year	0	1	2	3	4	5	6
		Investments: