Question

Conch Republic Electronics

Conch Republic Electronics is a mid sized electronics manufacturer located in Key West, Florida. The company president is Shelley Couts, who inherited the company. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company's finance department.

One of the major revenue-producing items manufactured by Conch Republic is a personal digital assistant (PDA). Conch Republic currently has one PDA model on the market, and sales have been excellent. The PDA 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 PDA has limited features in comparison with newer models. Conch Republic developed a prototype for a new PDA that has all the features of the existing PDA but adds new features such as cell phone capability. The company has performed a marketing study to determine the expected sales figures for the new PDA.

Conch Republic can manufacture the new PDA for $200 each in variable costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimated sales volume is 70,000, 80,000, 100,000, 85,000, and 75,000 per each year for the next five years, respectively. The unit price of the new PDA will be $340. The necessary equipment can be purchased for $16.5 million and will be depreciated on a 5 year straight-line schedule.

Net working capital investment for the PDAs will be $6,000,000 the first year of operations. Of course NWC will be recovered at the projects end. 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 and supporting commentary

1. What is the IRR of the project?
2. What is the NPV of the project, based on the required rate of return of 12%?  

Answer 1

WORKSHEET FOR FCF:	0	1	2	3	4	5
Sales volume [Units]		70000	80000	100000	85000	75000
Sales		23800000	27200000	34000000	28900000	25500000
Variable cost		14000000	16000000	20000000	17000000	15000000
Depreciation [16500000/5]		3300000	3300000	3300000	3300000	3300000
NOI		6500000	7900000	10700000	8600000	7200000
Tax at 35%		2275000	2765000	3745000	3010000	2520000
NOPAT		4225000	5135000	6955000	5590000	4680000
Add: Depreciation		3300000	3300000	3300000	3300000	3300000
OCF		7525000	8435000	10255000	8890000	7980000
Capital expenditure	16500000
Change in NWC	6000000					-6000000
FCF	-22500000	7525000	8435000	10255000	8890000	13980000
IRR is that discount rate for which NPV = 0, or at which PV of cash inflows = PV of cash outflows.
Such a discount rate is to be found out by trial and error.							NPV
Discounting with 30%, PVIF	1	0.76923	0.59172	0.45517	0.35013	0.26933
PV at 30%	-22500000	5788462	4991124	4667729	3112636	3765220	-174829
Discounting with 29%, PVIF	1	0.77519	0.60093	0.46583	0.36111	0.27993
PV at 29%	-22500000	5833333	5068806	4777124	3210280	3913439	302983
IRR lies between 29% and 30%. By simple interpolation IRR = 29%+1%*302983/(302983+174829) =					29.63%
PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
PV at 12%	-22500000	6718750	6724330	7299306	5649756	7932627
NPV	11824770