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 MBA graduate, has been hired by the company’s finance department.

One of the major revenue-producing items manufactured by Conch Republic is a smartphone. Conch Republic currently has one smartphone model on the market, and sales have been excellent. The smartphone is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Page 349Buffett music. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing smartphone 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 smartphone.

Conch Republic can manufacture the new smartphones 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 smartphone 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 $6.5 million.

As previously stated, Conch Republic currently manufactures a smartphone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smartphone, sales will be 95,000 units and 65,000 units for the next two years, respectively. The price of the existing smartphone is $385 per unit, with variable costs of $145 each and fixed costs of $4.3 million per year. If Conch Republic does introduce the new smartphone, sales of the existing smartphone will fall by 30,000 units per year, and the price of the existing units will have to be lowered to $215 each. Net working capital for the smartphones 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 21 percent corporate tax rate and a required return of 12 percent.

Shelley has asked Jay to prepare a report that answers the following questions.

QUESTIONS

What is the payback period of the project?

What is the profitability index of the project?

What is the IRR of the project?

What is the NPV of the project?

Answer 1

Answer :A Payback Period

Particular	Year 1	Year 2	Year 3	Year 4	Year 5
Unit Sold	155000	165000	125000	95000	75000
Unit Price	535	535	535	535	535
Revenue (A)	82925000	88275000	66875000	50825000	40125000
Variable Cost per unit	220	220	220	220	220
Variable Cost (B)	34100000	36300000	27500000	20900000	16500000
Contribution (C) = ( A) - ( B)	48825000	51975000	39375000	29925000	23625000
Fixed Cost (D)	6400000	6400000	6400000	6400000	6400000
Profit before tax and depriciation ( E = C-D)	42425000	45575000	32975000	23525000	17225000
Depriciation Rate	14.29%	24.49%	17.49%	12.49%	8.93%
Depriciation Amount ( F)	6216150	10653150	7608150	5433150	3884550
Profit before tax (G = E - F)	36208850	34921850	25366850	18091850	13340450
Tax (H)	7603858.5	7333588.5	5327039	3799289	2801495
Profit after tax ( G- H)	28604991.5	27588261.5	20039812	14292562	10538956
Depriciation	6216150	10653150	7608150	5433150	3884550
Cash Profit after tax	34821141.5	38241411.5	27647962	19725712	14423506

Payback Period

Initial Investment = 43.5 million ( equipment ) + 750000* ( Development of prototype) + 200000* ( market study) = $ 4,44,50,000

* Note : Initial Investment may be consider without Development of prototype expense and market study. But for the accurate working and calculation of requirement, these should be consider.

Cash Inflow	Cummulative
34821142	34821142
38241412	73062553
27647962	100710515
19725712	120436226
14423506	134859732

Payback Period = 1+ (( 44450000 - 34821142)/38241412)\

Payback Period = 1.25 years

Answer : B. Profitability Index

Year	Cash Flow	PV@12%	Present Value
1	34821142	0.893	31090304.91
2	38241412	0.797	30485819.12
3	27647962	0.712	19679272.89
4	19725712	0.636	12536046.27
5	14423506	0.567	8184284.374
		Present Value of Cash Inflow	101975727.6
		Initial Expenditure	44450000
		Profitability Index	2.29

Answer :C. IRR of the Project

Year	Cash Flows
0	-44450000
1	34821142
2	38241412
3	27647962
4	19725712
5	14423506
IRR	66.38%

Answer :D. NPV of the Project

Year	Cash Flows	PV@12%	Present Value
1	34821142	0.893	31090304.91
2	38241412	0.797	30485819.12
3	27647962	0.712	19679272.89
4	19725712	0.636	12536046.27
5	14423506	0.567	8184284.374
		Present Value of Cash Inflow	101975727.6
		Initial Cash Outflow	44450000
		NPV	57,525,727.56