Question

Conch Republic Electronics is a midsized 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 households 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 smartphone. Conch Republic currently has one smartphone model on the market, and sakes 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 music. however, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smartphone that has all features of the existing smartphone 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 smartphone for $220 each in variable costs. Fixed costs for the operation are estimated to run $6.4 million per year. The estimated sales Volume is 155,000, 165,000, 125,000, 95,000, and 75,000 per year for the next five years, respectively. The unit price of the new smartphone will be $535. The necessary equipment can be purchased fro $43.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.5 million.

As previously stated, Conch Republic currently manufactures a smartphone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smartphone, sales will be 95,000 units and 65,000 units for the next two years, respectively. The price of existing smartphone is $385 per unit, with variable costs of $145 each and fixed costs of $4.3 million per year. If Conch Republic does introduce the new smartphone, sales of the existing smartphone 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 21 percent corporate tax rate and a required return of 12 percent.

Shelley 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

	CONCH REPUBLIC ELECTRONICS:	0	1	2	3	4	5
	Sales in units of new smart phone		155000	165000	125000	95000	75000
	Sales revenue ($535)		82925000	88275000	66875000	50825000	40125000
	Variable cost ($220)		34100000	36300000	27500000	20900000	16500000
	Fixed costs (other than depreciation)		6400000	6400000	6400000	6400000	6400000
	Depreciation (7 Year MACRS) %		14.29	24.49	17.49	12.49	8.93
	Depreciation expense		6216150	10653150	7608150	5433150	3884550
	EBIT (New smart phone)		36208850	34921850	25366850	18091850	13340450
	Contribution lost on existing smart phone:
	Sales in units without new phone		95000	65000
	Contribution magin at $385-$145 = $240		22800000	15600000
	Sales in units with new phone		65000	35000
	Contribution margin at $215-$145 = $70		4550000	2450000
	Loss in contribution with new phone		18250000	13150000
	Incremental EBIT		17958850	21771850	25366850	18091850	13340450
	Tax at 21%		3771359	4572089	5327039	3799289	2801495
	NOPAT		14187492	17199762	20039812	14292562	10538956
	Add: Depreciation		6216150	10653150	7608150	5433150	3884550
	OCF		20403642	27852912	27647962	19725712	14423506
	Capital expenditure	43500000
	Change in NWC		16585000	1070000	-4280000	-3210000	-2140000
	Release of NWC						8025000
	After tax salvage value = [6500000+(9704850-6500000)*21%]						7173019
	After tax annual cash flows	-43500000	3818642	26782912	31927962	22935711.5	31761524
1)	PAYBACK PERIOD:
	Cumulative after tax cash flows	-43500000	-39681359	-12898447	19029515	41965226	73726750
	Payback period = 2+12898447/31927962 =	2.40	Years
2)	PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
	PV at 12%		3409501	21351173	22725692	14576059	18022342
	PI = PV of cash inflows/Initial investment = 80084768/43500000 =	1.84
3)	IRR:
	PVIF at 36% [PVIF = 1/1.12^n]	1	0.73529	0.54466	0.40345	0.29885	0.22137
	PV at 36%	-43500000	2807825	14587642	12881450	6854440	7031166
	PVIF at 37%	1	0.72993	0.53279	0.38890	0.28387	0.20720
	PV at 37%	-43500000	2787330	14269759	12416794	6510734	6581100
	IRR = 36+662523/(662523+934283) =	36.41%
4)	NPV:
	= PV of cash inflows-Initial investment = 80084768-43500000 =	$   3,65,84,768