Conch Republic Electronics Conch Republic Electronics is a midsized electronics
ID: 2384416 • Letter: C
Question
Conch Republic Electronics
Conch Republic Electronics is a midsized electronics manufacturer 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, had 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 $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, respectively. The unit price of the new smart phone 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 equipment in five years will be $5.5 million.
Net working capital for the smart phones 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 years sales. Conch Republic has a 35 percent corporate tax rate and a required rate of return of 12 percent.
Shelly 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?
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?
Explanation of how answers were achieved through formula would be very appreciated
Explanation / Answer
Net cash flow from operation 1 2 3 4 5 Sales in units 64000 106000 87000 78000 54000 Sales in $ $310,40,000 $514,10,000 $421,95,000 $378,30,000 $261,90,000 less variable cost $131,20,000 $217,30,000 $178,35,000 $159,90,000 $110,70,000 less fixed cost $51,00,000 $51,00,000 $51,00,000 $51,00,000 $51,00,000 less depreciation $49,30,050 $84,49,050 $60,34,050 $43,09,050 $30,80,850 Earnings before taxes $78,89,950 $161,30,950 $132,25,950 $124,30,950 $69,39,150 less taxes $27,61,483 $56,45,833 $46,29,083 $43,50,833 $24,28,703 Earnings after taxes $51,28,468 $104,85,118 $85,96,868 $80,80,118 $45,10,448 add deprecation $100,58,518 $189,34,168 $146,30,918 $123,89,168 $75,91,298 less/ working capital $62,08,000 $40,74,000 -$18,43,000 -$8,73,000 -$23,28,000 add equipment value net of taxes $62,68,933 Net cash flows after taxes $38,50,518 $148,60,168 $164,73,918 $132,62,168 $161,88,231 Depreciation under MACRS 1 14.29 $345,00,000 $49,30,050 2 24.49 $345,00,000 $84,49,050 3 17.49 $345,00,000 $60,34,050 4 12.49 $345,00,000 $43,09,050 5 8.93 $345,00,000 $30,80,850 $268,03,050 $345,00,000 6 8.92 $345,00,000 $30,77,400 $76,96,950 $55,00,000 7 8.93 $345,00,000 $30,80,850 -$21,96,950 8 4.46 $345,00,000 $15,38,700 -$7,68,933 $345,00,000 $62,68,933 Note: 1 we are assuming that the development cost is included in the fixed cost. 2 All working capital will be recouped in the 5th year. 3 The book value of equipment is more than the market value at the end of 5the year hence the tax benefit on the loss has been adjusted to determine the cash flow from equipment at the end of 5th year. 1) Payback period Net flow Cumulative 1 $38,50,518 $38,50,518 1 2 $148,60,168 $187,10,685 1 3 $164,73,918 $351,84,603 4 $132,62,168 $484,46,770 5 $161,88,231 $646,35,001 2.97 years or 3 years 2) Profitability index Net flow D.F - .12 PV 1 $38,50,518 0.8929 $34,37,962 2 $148,60,168 0.7972 $118,46,435 3 $164,73,918 0.7118 $117,25,809 4 $132,62,168 0.6355 $84,28,347 5 $161,88,231 0.5674 $91,85,637 $446,24,190 PI - 1.26 3) 0 (335,50,000) 1 3850518 2 14860168 3 16473918 4 13262168 5 16188231 IRR 22.76% 4) Present value of inflows 44624189.62 less initial investment (335,50,000) NPV positive 110,74,190 5) Sensitivity analysis by using break even point Contribution margin 485-205 $280 Highest fixed cost $135,49,050 Contribution margin required to make cover fixed cost $127.82 add variable cost $205 The selling price may be reduced to $332.82 At this selling price break even is 333-205 $128 105852 units The price may be reduced by 485-333 152 in % 31% If the price decreases by around 31% company will be in no profit no loss situation 6) Break even at the current price 48389 The difference in quantity 106000-48389 57611 If qty is decrease by 54% If decrease in quantity is 54% the company will be in no profit no loss situation. 7) Keeping in view the NPV and IRR the company can go for this project. 8) Definitely the affect of decrease in sales should be taken as it will reduce the profitability of the company as well.
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