Question
In: Finance
book: Fundamentals of Corporate Finance Alternate Edition (9th Edition) Conch Republic Electronics, Part 1 Conch Republic...
book: Fundamentals of Corporate Finance Alternate Edition (9th Edition)
Conch Republic Electronics, Part 1
Conch Republic Electronics is a small electronics manufacturer
located in Key West, Florida. The president of the company is
Shelley Couts, who inherited the business. When the company was
founded more than 70 years ago, it repaired radios and other
devices for the home. With the passage of time, the company
expanded to the manufacturing areas and today is a reputed producer
of various electronic items. Jay McCanless, a recent MBA graduate,
has been hired by the company's bail department. One of the main
devices manufactured by Conch Republic and that generates income in
a personalized digital assistant (PDA, acronym for personal digital
assistant). Today, Conch Republic has a PDA model in the market and
sales have remained at an excellent level. The PDA is a unique item
that comes in a variety of tropical colors and has been
preprogrammed to play Jimmy Buffett's music. However, as with any
electronic article, the technology changes the deprivation and the
real PDA has limited features compared to other more recent models.
Conch Republic spent $ 750,000 to develop the prototype of a new
PDA that has all the characteristics of the real, but adds new
features such as the capacity of a cell phone. The company has
spent an additional $ 200,000 for a marketing study to determine
the sales figures expected for the new PDA. Conch Republic can
manufacture the new PDA at a variable cost of $ 155 per unit. It
has been estimated that the operation costs will be 4.7 million per
year. The estimated volume of sales is 74,000, 95,000,125,000,
105,000 and 80,000 dollars annually for the next five years. The
unit price of the new PDA will be 360 ??dollars. The necessary
equipment can be purchased for 21.5 million dollars and depreciated
based on a seven-year MACRS program. It is considered that within
five years the value of the equipment will be 4.1 million dollars.
As you said, Conch Republic currently manufactures a PDA. It is
expected that the production of the model will be completed within
the years. If Conch Republic does not present the new PDA, sales
will be 80,000 and 60,000 units for the next two years. The price
of the real PDA is $ 290 per unit, with variable variables of $ 120
per year and costs of $ 1,800,000 per year. If Conch Republic truly
presents the new PDA, the actual PDA sales will decrease by 15,000
units per year and the price of the available units will decrease
by 255 dollars each. The net working capital for PDAs is 20% of
sales and the present with the periodicity of cash flows for the
year; for example, there is no initial outlay for the NWC, but
changes in the NWC will occur first in year 1 with the first year
sales. Conch Republic has a corporate rate of 35% and a required
return of 12%. Shelly has asked for a Jay to prepare a report that
answers the following questions.
Questions
1. What is the recovery period of the project?
2. What is the profitability index of the project?
3. What is the internal rate of return of the project?
4. What is the net present value of the project?
Solutions
Expert Solution
| Equipment | $21,500,000.00 | ||||
| Pretax salvage value | $4,100,000.00 | ||||
| R&D | $750,000.00 | ||||
| Marketing study | $200,000.00 | ||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
| Sales (units) | 74000 | 95000 | 125000 | 105000 | 80000 |
| Sales of old PDA | 80000 | 60000 | |||
| Lost sales | 15000 | 15000 | |||
| Depreciation rate | 14.29% | 24.49% | 17.49% | 12.49% | 8.93% |
| Price | $360.00 | ||||
| VC | $155.00 | ||||
| FC | $4,700,000.00 | ||||
| Price of old PDA | $290.00 | ||||
| Price reduction of Old PDA ($290 - $255) | $35.00 | ||||
| VC of old PDA | $120.00 | ||||
| Tax rate | 35.00% | ||||
| NWC percentage | 20.00% | ||||
| Required return | 12.00% | ||||
| Sales | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| New | $26,640,000.00 | $34,200,000.00 | $45,000,000.00 | $37,800,000.00 | $28,800,000.00 |
| Lost sales | -$4,350,000.00 | -$4,350,000.00 | $0.00 | $0.00 | $0.00 |
| Lost revenue | -$2,275,000.00 | -$1,575,000.00 | $0.00 | $0.00 | $0.00 |
| Net sales | $20,015,000.00 | $28,275,000.00 | $45,000,000.00 | $37,800,000.00 | $28,800,000.00 |
| VC | |||||
| New | $11,470,000.00 | $14,725,000.00 | $19,375,000.00 | $16,275,000.00 | $12,400,000.00 |
| Lost sales | -$1,800,000.00 | -$1,800,000.00 | $0.00 | $0.00 | $0.00 |
| Total VC | $9,670,000.00 | $12,925,000.00 | $19,375,000.00 | $16,275,000.00 | $12,400,000.00 |
| Sales | $20,015,000.00 | $28,275,000.00 | $45,000,000.00 | $37,800,000.00 | $28,800,000.00 |
| Less: VC | $9,670,000.00 | $12,925,000.00 | $19,375,000.00 | $16,275,000.00 | $12,400,000.00 |
| Less: Fixed costs | $4,700,000.00 | $4,700,000.00 | $4,700,000.00 | $4,700,000.00 | $4,700,000.00 |
| Less: Dep | $3,072,350.00 | $5,265,350.00 | $3,760,350.00 | $2,685,350.00 | $1,919,950.00 |
| EBT | $2,572,650.00 | $5,384,650.00 | $17,164,650.00 | $14,139,650.00 | $9,780,050.00 |
| Less: Tax | $900,427.50 | $1,884,627.50 | $6,007,627.50 | $4,948,877.50 | $3,423,017.50 |
| NI | $1,672,222.50 | $3,500,022.50 | $11,157,022.50 | $9,190,772.50 | $6,357,032.50 |
| +Dep | $3,072,350.00 | $5,265,350.00 | $3,760,350.00 | $2,685,350.00 | $1,919,950.00 |
| OCF | $4,744,572.50 | $8,765,372.50 | $14,917,372.50 | $11,876,122.50 | $8,276,982.50 |
| NWC | |||||
| Beg | 0 | $4,003,000.00 | $5,655,000.00 | $9,000,000.00 | $7,560,000.00 |
| End | $4,003,000.00 | $5,655,000.00 | $9,000,000.00 | $7,560,000.00 | $0.00 |
| NWC CF | -$4,003,000.00 | -$1,652,000.00 | -$3,345,000.00 | $1,440,000.00 | $7,560,000.00 |
| Net CF | $741,572.50 | $7,113,372.50 | $11,572,372.50 | $13,316,122.50 | $15,836,982.50 |
| Salvage | $4,100,000.00 | ||||
| BV of equipment = Cost of Equipment - Depreciation) | $4,796,650.00 | ||||
| Taxes (BV - MV) x Tax Rate | $243,827.50 | ||||
| Salvage CF = $4,100,000 + 243,827.50) | $4,343,827.50 | ||||
| a) | |||||
| Time | Cash flow | Cumulative Cash Flow | |||
| 0 | -$21,500,000.00 | -$20,758,427.50 | |||
| 1 | $741,572.50 | -$20,016,855.00 | |||
| 2 | $7,113,372.50 | -$12,903,482.50 | |||
| 3 | $11,572,372.50 | -$1,331,110.00 | |||
| 4 | $13,316,122.50 | $11,985,012.50 | |||
| 5 | $20,180,810.00 | ||||
| Payback period = 3 + $1331110/13316122.50 | 3.100 | Years | |||
| b) | |||||
| Time | Cash flow | PV @ 12% | Present Value | ||
| 1 | $741,572.50 | 0.8929 | $662,118.30 | ||
| 2 | $7,113,372.50 | 0.7972 | $5,670,737.01 | ||
| 3 | $11,572,372.50 | 0.7118 | $8,236,986.17 | ||
| 4 | $13,316,122.50 | 0.6355 | $8,462,636.58 | ||
| 5 | $20,180,810.00 | 0.5674 | $11,451,133.56 | ||
| Total | $34,483,611.62 | ||||
| Profitability Index = (PV of future cash flows) ÷ Initial investment | |||||
| Profitability Index = $34,483,611.62/21,500,000 | 1.604 | ||||
| c) & d) | Time | Cash flow | PV @ 12% | Present Value | |
| 0 | -$21,500,000.00 | 1.0000 | -$21,500,000.00 | ||
| 1 | $741,572.50 | 0.8929 | $662,118.30 | ||
| 2 | $7,113,372.50 | 0.7972 | $5,670,737.01 | ||
| 3 | $11,572,372.50 | 0.7118 | $8,236,986.17 | ||
| 4 | $13,316,122.50 | 0.6355 | $8,462,636.58 | ||
| 5 | $20,180,810.00 | 0.5674 | $11,451,133.56 | ||
| IRR | c) | 27.62% | NPV | $12,983,611.62 | d) |
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