Conch Republic Electronics is a midsized electronics manufacturer located in Key
ID: 2481968 • Letter: C
Question
Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelley Couts, who inherited the company. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. 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. Conch republic spent $850,000 to develop a prototype for a new smart phone that has all the features of their existing smart phones. The company has spent a further $300,000 for a marketing study to determine the expected sales firgures for the new smart phone. Conch republic can manufacture the new smart phones for $200 each in variable costs. Fixed costs for the operation are estimated to run $6 million per year. The estimated sales volume is 60,000, 105,000, 85,000, 80,000, and 55,000 per year for the next five years, respectively. The unit price of the new smart phone will be $500. 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 $6.5 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 year's sales. Conch republic has a 40 percent corporate tax rate and a 12 percent average cost of capital. A.) What is the payback period of the project? B.) What is the Internal rate of return of the project? C.) What is the Net present value of the project? D.) Should Conch Republic produce the new Smart Phone E) determine profitability index
Explanation / Answer
Year 1 Year 2 Year 3 Year 4 Year 5 Sales per unit 500 500 500 500 500 Less variable costs 200 200 200 200 200 Contribution per unit 300 300 300 300 300 Sales Volume 60,000 1,05,000 85,000 80,000 55,000 Contribution margin 1,80,00,000 3,15,00,000 2,55,00,000 2,40,00,000 1,65,00,000 Less Fixed costs 60,00,000 60,00,000 60,00,000 60,00,000 60,00,000 Less Depreciation (34.5-6.5)/7 40,00,000 40,00,000 40,00,000 40,00,000 40,00,000 Profit before tax 80,00,000 2,15,00,000 1,55,00,000 1,40,00,000 65,00,000 Tax @ 40% 32,00,000 86,00,000 62,00,000 56,00,000 26,00,000 Profit after tax 48,00,000 1,29,00,000 93,00,000 84,00,000 39,00,000 Add Depreciation 40,00,000 40,00,000 40,00,000 40,00,000 40,00,000 Cash inflow 88,00,000 1,69,00,000 1,33,00,000 1,24,00,000 79,00,000 Cash out flow $ Machine cost 3,45,00,000 Development costs 8,50,000 Marketing study costs 3,00,000 Total 3,56,50,000 Net working capital 20% of (500*60000) 60,00,000 Total cash outflow 4,16,50,000 Cash inflow Cumulative cash inflow Year 1 88,00,000 88,00,000 Year 2 1,69,00,000 2,57,00,000 Year 3 1,33,00,000 3,90,00,000 Year 4 1,24,00,000 5,14,00,000 Year 5 79,00,000 5,93,00,000 Payback period = (Cash outflow-cumulative cash inflow(n-1)/Cash inflow(n)) * + (n-1) PBP = ((41,650,000-39,000,000)/12,400,000)+3 PBP = 0.21 + 3 = 3.21 years Cash inflow PVIF@12% PV of cash inflow Year 1 -4,16,50,000 1 -4,16,50,000 Year 1 88,00,000 0.89 78,57,143 Year 2 1,69,00,000 0.80 1,34,72,577 Year 3 1,33,00,000 0.64 84,52,390 Year 4 1,24,00,000 0.40 50,08,152 Year 5 79,00,000 0.16 12,88,661 1,76,50,000 -55,71,077 NPV = (-5,571,077) Cash inflow PVIF@ 7.851% PV of cash inflow Year 1 -4,16,50,000 1.00 -4,16,50,000 Year 1 88,00,000 0.93 81,59,405 Year 2 1,69,00,000 0.86 1,45,29,088 Year 3 1,33,00,000 0.74 98,30,032 Year 4 1,24,00,000 0.55 67,73,736 Year 5 79,00,000 0.30 23,57,438 1,76,50,000 -301 IRR = 7.851% Profitability index = (Total cash inflow - Cash outflow) / cash outflow Profitability index = (59,300,000-41,650,000) / 41,650,000 Profitability index = 0.42 Conch Republic should not produce the new Smart Phone because the NPV is negative
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