Question

Conch Republic Electrics locates in Key West, Florida. The President is Shelley Couts, who inherited the company. The company is a reputable manufacturer of various electronic items. Jay McCanless, a recent Business 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. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Conch spent $750000 to develop a prototype for a new PDA that has all the features of existing PDA but adds newer features which market demands. The company has spent a further $200000 for a marketing and sale promotion.

Conch republic manufactures the new PDA for $150 each in variables costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimate sale volume is 70000, 80000, 100000, 85000, and 75000 per each year for the next four 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 seven-year MACRS schedule. It is believed the value of the equipment in five years will be $3.5 million. Net working capital for the PDAs will be 20% of sales and will occur with the timing of the cash flows for the year. Conch Republic has a 35% tax rate and 12% required return.

Shelley has asked jay to prepare a report that answers the following questions:

What is the IRR of the new project? (10%)

What is the NPV of the new project? (10%)

Challenge Part of Case #2

Production of the existing model is expected to be terminated in two years. If Conch republic does not introduce the new PDA, sales will be 80000 units and 60000 units for the next two years respectively. The price of the existing PDA is $ 280 per unit, with variable costs of $120 each and fixed costs of $1800000 per year. If Conch Republic dose introduce the new PDA, sales of the existing PDA will fall by 15000 units per year, and the price will have to be lowered to $240 each. Consider this change of operation cash flows,

What is the NPV of the new project? (10%)

Answer 1

CONCH REPUBLIC ELECTRICS:	0	1	2	3	4	5
Sales in units of new PDA		70000	80000	100000	85000	75000
Sales revenue ($340)		$     2,38,00,000	$      2,72,00,000	$    3,40,00,000	$ 2,89,00,000	$ 2,55,00,000
Variable cost ($150)		$     1,05,00,000	$      1,20,00,000	$    1,50,00,000	$ 1,27,50,000	$ 1,12,50,000
Fixed costs (other than depreciation)		$        45,00,000	$          45,00,000	$       45,00,000	$     45,00,000	$      45,00,000
Depreciation (7 Year MACRS) %		14.29	24.49	17.49	12.49	8.93	Total Depreciation	Book Value
Depreciation expense		$        23,57,850	$          40,40,850	$       28,85,850	$     20,60,850	$      14,73,450	$ 1,28,18,850	$     36,81,150
EBIT (New PDA)		$        64,42,150	$          66,59,150	$    1,16,14,150	$     95,89,150	$      82,76,550
Tax at 35%		$        22,54,753	$          23,30,703	$       40,64,953	$     33,56,203	$      28,96,793
NOPAT		$        41,87,398	$          43,28,448	$       75,49,198	$     62,32,948	$      53,79,758
Add: Depreciation		$        23,57,850	$          40,40,850	$       28,85,850	$     20,60,850	$      14,73,450
OCF		$        65,45,248	$          83,69,298	$    1,04,35,048	$     82,93,798	$      68,53,208
Capital expenditure	$        1,65,00,000
Change in NWC		$        47,60,000	$            6,80,000	$       13,60,000	$   -10,20,000	$      -6,80,000
Release of NWC						$      51,00,000
After tax salvage value = [3500000+(3681150-3500000)*35%]						$      35,63,403
After tax annual cash flows	$      -1,65,00,000	$        17,85,248	$          76,89,298	$       90,75,048	$     93,13,798	$ 1,61,96,610	27560000
PAYBACK PERIOD:
Cumulative after tax cash flows	$      -1,65,00,000	$   -1,47,14,753	$        -70,25,455	$       20,49,593	$ 1,13,63,390	$ 2,75,60,000
Payback period = 2+7025455/9075048 =	2.77	Years
PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
PV at 12%		$        15,93,971	$          61,29,861	$       64,59,440	$     59,19,087	$      91,90,391	29292750
PI = PV of cash inflows/Initial investment = 29292750/16500000 =	1.78
IRR:
PVIF at 32%	1	0.75758	0.57392	0.43479	0.32939	0.24953
PV at 32%	$      -1,65,00,000	$        13,52,460	$          44,13,050	$       39,45,728	$     30,67,828	$      40,41,611	$        3,20,677
PVIF at 33%	1	0.75188	0.56532	0.42505	0.31959	0.24029
PV at 33%	$      -1,65,00,000	$        13,42,291	$          43,46,937	$       38,57,394	$     29,76,598	$      38,91,938	$          -84,841
IRR = 32%+1%*320677/(320677+84841) =	32.79%
NPV:
= PV of cash inflows-Initial investment = 29292750-16500000 =	$        1,27,92,750

PART 2:

EBIT (New PDA)		$        64,42,150	$          66,59,150	$    1,16,14,150	$     95,89,150	$      82,76,550
Contribution lost on existing PDA:
Sales in units without new PDA		80000	60000
Contribution magin at $280-$120 = $160		$     1,28,00,000	$          96,00,000
Sales in units with new PDA		65000	45000
Contribution margin at $240-$120 = $120		$        78,00,000	$          54,00,000
Loss in contribution on existing PDA		$        50,00,000	$          42,00,000
Incremental EBIT		$        14,42,150	$          24,59,150	$    1,16,14,150	$     95,89,150	$      82,76,550
Tax at 35%		$           5,04,753	$            8,60,703	$       40,64,953	$     33,56,203	$      28,96,793
NOPAT		$           9,37,398	$          15,98,448	$       75,49,198	$     62,32,948	$      53,79,758
Add: Depreciation		$        23,57,850	$          40,40,850	$       28,85,850	$     20,60,850	$      14,73,450
OCF		$        32,95,248	$          56,39,298	$    1,04,35,048	$     82,93,798	$      68,53,208
Capital expenditure	$        1,65,00,000
Change in NWC		$        47,60,000	$            6,80,000	$       13,60,000	$   -10,20,000	$      -6,80,000
Release of NWC						$      51,00,000
After tax salvage value = [3500000+(3681150-3500000)*35%]						$      35,63,403
After tax annual cash flows	$      -1,65,00,000	$       -14,64,753	$          49,59,298	$       90,75,048	$     93,13,798	$ 1,61,96,610	21580000
PAYBACK PERIOD:
Cumulative after tax cash flows	$      -1,65,00,000	$   -1,79,64,753	$    -1,30,05,455	$      -39,30,408	$     53,83,390	$ 2,15,80,000
Payback period = 3+3930408/9313798 =	3.42	Years
PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
PV at 12%		$       -13,07,815	$          39,53,522	$       64,59,440	$     59,19,087	$      91,90,391	24214625
PI = PV of cash inflows/Initial investment = 24214625/16500000 =	1.47
IRR:
PVIF at 24%	1	0.80645	0.65036	0.52449	0.42297	0.34111
PV at 24%	$      -1,65,00,000	$       -11,81,252	$          32,25,350	$       47,59,747	$     39,39,490	$      55,24,789	$      -2,31,876
PVIF at 23%	1	0.81301	0.66098	0.53738	0.43690	0.35520
PV at 23%	$      -1,65,00,000	$       -11,90,856	$          32,78,007	$       48,76,785	$     40,69,175	$      57,53,056	$        2,86,167
IRR = 23%+1%*286167/(286167+231876) =	23.55%
NPV:
= PV of cash inflows-Initial investment = 24214625-16500000 =	$           77,14,625