Question

Please answer with Excel Formulas:

Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was founded over 70 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. Jay McCanless, a recent MBA graduate, had been hired by the company in its 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 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 $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 If 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. Shelly has asked Jay to prepare a report that answers the following questions:

Questions 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?

Answer 1

	STEP1	EROSION OF THE EXISTING MODEL
			Year	0	1	2
		A	Unit Sales(Without intorducing new model)		80000	60000
		B	Contribution per unit(310-125)		$                      185	$                      185
		C=A*B	Total Contribution(without introduction of new model)		$        14,800,000	$       11,100,000
		D	Unit sales(if new model is introduced)		65000	45000
		E	Contribution per unit(275-125)		$                      150	$                      150
		F=D*E	Total Contribution(if new model is introduced)		$          9,750,000	$          6,750,000
		G=F-C	Cash flow due to erosion of the existing model		$        (5,050,000)	$       (4,350,000)
		STEP2	DEPRECIATION TAX SHIELD AND SALVAGE VALUE
			Year	0	1	2	3	4	5
		H	MACRS 7 Year Depreciation rate		14.29%	24.49%	17.49%	12.49%	8.93%
		I=H*$38.5 million	Depreciation Expense		$          5,501,650	$          9,428,650	$     6,733,650	$        4,808,650	$         3,438,050
		J	Accumulated depreciation		$          5,501,650	$       14,930,300	$21,663,950	$     26,472,600	$      29,910,650
		K=$38.5 million-J	Book Value at the end of 5 years						$         8,589,350
		L	Salvage value at the end of 5 years						$5,400,000
		M=0,35*(K-L)	Tax saving due to capital loss						$         1,116,273
		N=0.35*I	Depreciation Tax shield		$          1,925,578	$          3,300,028	$     2,356,778	$        1,683,028	$         1,203,318
		O=L+M+N	Cash flow due to depreciation tax shield and Salvage		$          1,925,578	$          3,300,028	$     2,356,778	$        1,683,028	$         7,719,590
		STEP 3	CASH FLOW DUE TO PROJECTED INVESTMENT AND SALES
		Z	Year	0	1	2	3	4	5	6
		P	Initial investment	($38,500,000)
		Q	Unit sales		74000	95000	125000	105000	80000
		R=480-185	Contribution per unit		$                      295	$                      295	$                 295	$                    295	$                     295
		S=P*Q	Total Contribution		$        21,830,000	$       28,025,000	$36,875,000	$     30,975,000	$      23,600,000
		T	Fixed Costs		$5,300,000	$5,300,000	$5,300,000	$5,300,000	$5,300,000
		U=S-T	Before tax Cash flow from Sales		$        16,530,000	$       22,725,000	$31,575,000	$     25,675,000	$      18,300,000
		V=P+U*(1-0.35)	After tax cash flow from Sales and investment	($38,500,000)	$        10,744,500	$       14,771,250	$20,523,750	$     16,688,750	$      11,895,000
		STEP 4	CASH FLOW FROM NET WORKING CAPITAL CHANGES
		W=0.2*Q*480	Ner Working Capital Required		$          7,104,000	$          9,120,000	$12,000,000	$     10,080,000	$         7,680,000
		X	Cash flow due to change in net working capital		$        (7,104,000)	$       (2,016,000)	($2,880,000)	$        1,920,000	$         2,400,000	$      7,680,000
		Y=G+O+V+X	NET AFTER TAX CASH FLOW	($38,500,000)	$516,078	$11,705,278	$20,000,528	$20,291,778	$22,014,590	$7,680,000
			CUMULATIVE CASH FLOW	($38,500,000)	($37,983,923)	($26,278,645)	($6,278,118)	$14,013,660	$36,028,250	$43,708,250	SUM
		PV=Y/(1.12^Z)	PRESENT VALUE OF CASH FLOW AT 12% DISCOUNT RATE	$       (38,500,000)	$              460,783	$          9,331,376	$14,235,980	$     12,895,791	$      12,491,670	$      3,890,927	$14,806,527
	1	NPV=	Sum of Present Value of Cash flows=	$          14,806,527
	2	PAY BACK PERIOD	Period at which Cumulative cash flow=Zero	3.31	Years	(3+(6278118/20291778)
	3	IRR	Internal Rate of return (Using IRR function of excel)	22.38%
			NOTE:
			Amount spent to develop prototype	$750,000
			Marketing study expenses already incurred	$200,000
			Total	$950,000
			These are sunk costs and not considered
			These expenses do not influence the decision