Question

Conch Republic Electronics Part 1

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 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.

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 95,000 units and 65,000 units for the next two years, respectively. The price of the existing smart phone is $380 per unit, with variable costs of $145 each and fixed costs of $4.3 million per year. If Conch Republic does introduce the new smart phone, sales of the existing smart phone will fall by 30,000 units per year, and the price of the existing units will have to be lowered to $210 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 required return of 12 percent.

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

Conch Republic Electronics Part 2

Shelley Couts, the owner of Conch Republic Electronics, had received the capital budgeting analysis from Jay McCanless for the new smart phone the company is considering. Shelley was pleased with the results, but she still had concerns about the new smart phone. Conch Republic had used a small market research firm for the past 20 years, but recently the founder of that firm retired. Because of this, she was not convinced the sales projections presented by the market research firm were entirely accurate. Additionally, because of rapid changes in technology, she was concerned that a competitor could enter the market. This would likely force Conch Republic to lower the sales price of its new smart phone. For these reasons, she has asked Jay to analyze how changes in the price of the new smart phone and changes in the quantity sold will affect the NPV of the project.

Shelley has asked Jay to prepare a memo answering the following questions.

QUESTIONS

5.How sensitive is the NPV to changes in the price of the new smart phone?

6.How sensitive is the NPV to changes in the quantity sold of the new smart phone?

Answer 1

Equipment	$40,500,000.00
Pretax salvage value	$6,100,000.00
R&D	$750,000.00
Marketing study	$200,000.00
	Year 1	Year 2	Year 3	Year 4	Year 5
Sales (units)	155000	165000	125000	95000	75000
Sales of old PDA	95000	65000
Lost sales	30000	30000
Depreciation rate	14.29%	24.49%	17.49%	12.49%	8.93%
Price	$520.00
VC	$215.00
FC	$6,100,000.00
Price of old PDA	$380.00
Price reduction of Old PDA ($380 - $210)	$170.00
VC of old PDA	$145.00
Tax rate	35.00%
NWC percentage	20.00%
Required return	12.00%
Sales	Year 1	Year 2	Year 3	Year 4	Year 5
New	$80,600,000.00	$85,800,000.00	$65,000,000.00	$49,400,000.00	$39,000,000.00
Lost sales	-$11,400,000.00	-$11,400,000.00	$0.00	$0.00	$0.00
Lost revenue	-$11,050,000.00	-$5,950,000.00	$0.00	$0.00	$0.00
Net sales	$58,150,000.00	$68,450,000.00	$65,000,000.00	$49,400,000.00	$39,000,000.00
VC
New	$33,325,000.00	$35,475,000.00	$26,875,000.00	$20,425,000.00	$16,125,000.00
Lost sales	-$4,350,000.00	-$4,350,000.00	$0.00	$0.00	$0.00
Total VC	$28,975,000.00	$31,125,000.00	$26,875,000.00	$20,425,000.00	$16,125,000.00
Sales	$58,150,000.00	$68,450,000.00	$65,000,000.00	$49,400,000.00	$39,000,000.00
Less: VC	$28,975,000.00	$31,125,000.00	$26,875,000.00	$20,425,000.00	$16,125,000.00
Less: Fixed costs	$6,100,000.00	$6,100,000.00	$6,100,000.00	$6,100,000.00	$6,100,000.00
Less: Dep	$5,787,450.00	$9,918,450.00	$7,083,450.00	$5,058,450.00	$3,616,650.00
EBT	$17,287,550.00	$21,306,550.00	$24,941,550.00	$17,816,550.00	$13,158,350.00
Less: Tax	$6,050,642.50	$7,457,292.50	$8,729,542.50	$6,235,792.50	$4,605,422.50
NI	$11,236,907.50	$13,849,257.50	$16,212,007.50	$11,580,757.50	$8,552,927.50
+Dep	$5,787,450.00	$9,918,450.00	$7,083,450.00	$5,058,450.00	$3,616,650.00
OCF	$17,024,357.50	$23,767,707.50	$23,295,457.50	$16,639,207.50	$12,169,577.50
NWC
Beg	0	$11,630,000.00	$13,690,000.00	$13,000,000.00	$9,880,000.00
End	$11,630,000.00	$13,690,000.00	$13,000,000.00	$9,880,000.00	$7,800,000.00
NWC CF	-$11,630,000.00	-$2,060,000.00	$690,000.00	$3,120,000.00	$2,080,000.00
Net CF	$5,394,357.50	$21,707,707.50	$23,985,457.50	$19,759,207.50	$14,249,577.50
Salvage	$6,100,000.00
BV of equipment = Cost of Equipment - Depreciation)	$9,035,550.00
Taxes (BV - MV) x Tax Rate	$1,027,442.50
Salvage CF = $6,100,000 + 1,027,442.50)	$7,127,442.50
Time	Cash flow	PV @ 12%	Present Value
0	-$40,500,000.00	1.0000	-$40,500,000.00
1	$5,394,357.50	0.8929	$4,816,390.62
2	$21,707,707.50	0.7972	$17,305,251.51
3	$23,985,457.50	0.7118	$17,072,374.88
4	$19,759,207.50	0.6355	$12,557,333.58
5	$21,377,020.00	0.5674	$12,129,895.24
		NPV	$23,381,245.85
Price per unit	NPV	Sensitivity of NPV to price
Decrease $10	$20,554,286.40	-$282,695.94
Neutral	$23,381,245.85	$0.00
Increase $10	$26,208,205.30	$282,695.94
For a $10 change in price of the new SMART PHONE, the NPV of the project changes $282695.94 in the same direction
f)
Units	NPV	Sensitivity of NPV to units sold
Decrease 100 units per year	$23,319,066.87	-$6,217.90
Neutral	$23,381,245.85	$0.00
Increase 100 units per year	$23,443,424.82	$6,217.90
For a one unit per year change in quantity sold of the new SMART PHONE, the NPV of the project changes $621.79 in the same direction.