Question

Conch Republic Electronics is a midsized electronics Q1anufacturer 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, has 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 $199 each in variable costs. Fixed costs for the operation are estimated to run $5.5 Million per year. The estimated sales volume is 64,000, 115,000, 90,000, 75,000, 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 $60 Million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.25 Million.

Net working capital for the smart phones will be 22 percent of sales and will occur with the time of cash flows for the year (i.e. there is no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year’s sales. Conch Republic has 22 percent tax rate and a required return of 12 percent.

Shelly has asked Jay to prepare a report that answer the following questions using Microsoft EXCEL:

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?

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?

7. Should Conch Republic produce the new smart

phone?

8. Suppose Conch Republic loses sales on other

models because of the introduction of the new

model. How would this affect your analysis?

Answer 1

The free cash flow can be calculated as follows:
Free Cash Flow = Operating Cash Flow - Capital Expenditures - Change in working capital
Operating Cash Flow = EBIT*(1-Tax Rate)+Depreciation