Question

Conch Republic spent $750,000 to develop a prototype for a new smart phone that has all the features of the existing one 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 phone for $205 each in variable costs. Fixed costs for the operation are estimated to run $5.1 million per year. The estimated sales volume is 64,000, 106,000, 87,000, 78,000, and 54,000 per year for the next five years, respectively. The unit price of the new smart phone will be $485. The necessary equipment can be purchased for $34.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $5.5 million. 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 (i.e., there is no initial out-lay for NWC). Changes in NWC will thus 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. Shelly has asked Jay to prepare a report that answers the following questions:

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

f. How sensitive is the NPV to changes in the quantity sold?

g. Should Conch Republic produce the new smart phone?

Answer 1

Yes, Conch Republic should produce the new smart phone as it is a positive NPV Project.

Ignore the prototype development and marketing costs as they are sunk costs.

For sensitivity of NPV to changes in the price/quantity sold, you need to increase and decrease those cells and see the change in NPV.

Below are the formulas for your perusal.

	0	1	2	3	4	5	6	7
Sales Volume		64000	106000	87000	78000	54000
Sales Price Per Unit		485	485	485	485	485
Variable Costs Per Unit		205	205	205	205	205
Tangible Equipment Cost	=-34500000
Sales		=C2*C3	=D2*D3	=E2*E3	=F2*F3	=G2*G3
Fixed Costs		5100000	5100000	5100000	5100000	5100000
Variable Costs		=C4*C2	=D4*D2	=E4*E2	=F4*F2	=G4*G2
Depreciation Tax Shield (=D x T)		=C26*$B$22	=D26*$B$22	=E26*$B$22	=F26*$B$22	=G26*$B$22
Net Working Capita1		=0.2*C8	=0.2*D8	=0.2*E8	=0.2*F8	=0.2*G8
Change in Net Working Capital		=C12-B12	=D12-C12	=E12-D12	=F12-E12	=G12-F12
sale of Equipment (salvage value)						5500000
Tax Benefit (As sold at a loss)						=(G27-G14)*B22
After Tax Cash flow of Equipment At disposal
Operating Cash Flow		=(C8-SUM(C9:C10))*(1-$B$22)+C11-C13	=(D8-SUM(D9:D10))*(1-$B$22)+D11-D13	=(E8-SUM(E9:E10))*(1-$B$22)+E11-E13	=(F8-SUM(F9:F10))*(1-$B$22)+F11-F13	=(G8-SUM(G9:G10))*(1-$B$22)+G11-G13
Terminal Cash Flow (Including Release of Working Capital)						=G14+G15+G12
Incremental Cash Flows	=SUM(B6:B15)	=SUM(C17:C18)	=SUM(D17:D18)	=SUM(E17:E18)	=SUM(F17:F18)	=SUM(G17:G18)
Required Return	0.12
IRR	=IRR(B19:G19)
Marginal Tax Rate	0.35
NPV	=NPV(B20,C19:G19)+B19
Annual Depr % MACRS		0.1429	0.2449	0.1749	0.1249	0.0893	0.0893	0.0893	0.0445
Annual Depr $ (D)		=C25*$B$6*-1	=D25*$B$6*-1	=E25*$B$6*-1	=F25*$B$6*-1	=G25*$B$6*-1	=H25*$B$6*-1	=I25*$B$6*-1	=J25*$B$6*-1
Book Value of System		=-B6-C26	=C27-D26	=D27-E26	=E27-F26	=F27-G26	=G27-H26	=H27-I26	=I27-J26