Question

Case Study 05:

Conch Republic Electronics

Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The com- pany

president is Shelly Couts, who inherited the com- pany. The company originally repaired radios and other household appliances when it was founded more than 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 manu- factured by Conch Republic is a smartphone. Conch Republic currently has one smartphone model on the market and sales have been excellent. The smartphone is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett mu- sic. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Re- public spent $750,000 to develop a prototype for a new smartphone 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 smartphone.

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, re- spectively. The unit price of the new smartphone 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 equip- ment in five years will be $5.5 million.

Net working capital for the smartphones 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 outlay 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 an- swers the following questions:

How sensitive is the NPV to changes in the price of the new smartphone?

How sensitive is the NPV to changes in the quan- tity sold?

Should Conch Republic produce the new smartphone?

Suppose Conch Republic loses sales on other models because of the introduction of the new model. How

would this affect your analysis?

Answer 1

7-year MACRS depreciation schedule:

Operating cash flow calculation:

Base-case NPV calculation:

1). The smart phones can be produced as the NPV is positive.

Sensitivity analysis:

2). Using the base-case valuation table above, we change price from 485 to 585 per unit.

Then,

Price per unit = 585: NPV = 30,999,740.60

Base case: Price per unit = 485; NPV = 13,096,371.21

Sensitivity of NPV to price = change in NPV/change in price

= (30,999,740.60-13,096,371.21)/(585-485) = 179,033.69

3). Sensitivity of NPV to quantity sold:

Increase quanity sold per year by 100.

Then, using the base-case valuation table, NPV becomes 13,158,821.46

Sensitivity of NPV to quantity sold = change in NPV/change in units sold = (13,158,821.96-13,096,371.21)/100 = 624.50

4). If sales of other models decrease due to the introduction of the new smart phone, the decrease in sales will have to be factored in the NPV analysis. It will lead to a decrease in the NPV of the new smart phone.