Conch Republic Electronics is a midsized electronics manufacturer located in Key
ID: 2647228 • Letter: C
Question
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 figure manufacturer of various specialty electronic items. Jay McCanless, a recent MBA graduate, has 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 year's sales. Conch Republic has a 35 percent corporate tax rate and a 12 percent required return. Should Conch Republic produce the new smart phone?
Explanation / Answer
Answer:
Note:
Year 1 2 3 4 5 Explanation Sales in units 64000 106000 87000 78000 54000 Given Sales in $ 31040000 51410000 42195000 37830000 26190000 units x 485 less variable cost 13120000 21730000 17835000 15990000 11070000 units *205 fixed cost 5100000 5100000 5100000 5100000 5100000 given less depreciation 4930050 8449050 6034050 4309050 3080850 34500000*rate Income before taxes 7889950 16130950 13225950 12430950 6939150 Sales less all cost less taxes 2761482.5 5645832.5 4629082.5 4350833 2428703 Income before taxes * tax rate Net Income 5128467.5 10485117.5 8596867.5 8080118 4510448 add depreciation 4930050 8449050 6034050 4309050 3080850 Cash flow after taxes 10058518 18934167.5 14630918 12389168 7591298 add NWC 6208000 4074000 -1843000 7178000 15617000 Sales*.2- NWC already provided upto previous years In year 5 all NWC will be recovered Net operating cash flow 3850517.5 14860167.5 16473918 5211168 23208298 add salvage value after taxes 6268933 Net cash flow after taxes 3850517.5 14860167.5 16473918 5211168 29477230 Salvage value after taxes Cost of project 34500000 less Accumulated Dep 5 years 26803050 Book value 7696950 less salvage value 5500000 Loss on sales of porject 2196950 tax saving due to loss 768932.5 Salvage value after tax 6268932.5 (Salvage value+Tax Saving due to loss) Payback period Year Cash flow Payback period 0 -34500000 -34500000 1 3850517.5 -30649482.5 1 2 14860168 -15789315 1 3 16473918 15789315/16473918 0.96 4 5211167.5 2.96 years 5 29477230 Calculation of NPV: Year Cash flow PVIFat 12% PV 0 -34500000 1 -34500000 1 3850517.5 0.892857143 3437962.1 2 14860168 0.797193878 11846435 3 16473918 0.711780248 11725809 4 5211167.5 0.635518078 3311791.2 5 29477230 0.567426856 16726172 NPV 12548169 3 NPV positive 12548169 IRR 23.06% If the price is reduced by 20% and it is around $388 instead of 485, all calculations will be as follows: Year 1 2 3 4 5 Sales in units 64000 106000 87000 78000 54000 Sales in $ 24832000 41128000 33756000 30264000 20952000 less variable cost 13120000 21730000 17835000 15990000 11070000 fixed cost 5100000 5100000 5100000 5100000 5100000 less depreciation 4930050 8449050 6034050 4309050 3080850 Income before taxes 1681950 5848950 4786950 4864950 1701150 less taxes 588682.5 2047132.5 1675432.5 1702733 595402.5 Net Income 1093267.5 3801817.5 3111517.5 3162218 1105748 add depreciation 4930050 8449050 6034050 4309050 3080850 Cash flow after taxes 6023317.5 12250867.5 9145567.5 7471268 4186598 add NWC 4966400 3259200 -1474400 5742400 12493600 Net operating cash flow 1056917.5 8991667.5 10619968 1728868 16680198 add salvage value after taxes 6268933 Net cash flow after taxes 1056917.5 8991667.5 10619968 1728868 22949130 Year Cash flow PVIFat 12% PV 0 -34500000 1 -34500000 1 1056917.5 0.892857143 943676.34 2 8991667.5 0.797193878 7168102.3 3 10619968 0.711780248 7559083.1 4 1728867.5 0.635518078 1098726.6 5 22949130 0.567426856 13021953 NPV -4708459 If the price falls by 20% then the NPV becomes negative and by very low amount of around $7839710. If quantity is redcued by 20% as expected and the selling price remains as $485, the NPV will be Year 1 2 3 4 5 Sales in units 51200 84800 69600 62400 43200 Sales in $ 24832000 41128000 33756000 30264000 20952000 less variable cost 10496000 17384000 14268000 12792000 8856000 fixed cost 5100000 5100000 5100000 5100000 5100000 less depreciation 4930050 8449050 6034050 4309050 3080850 Income before taxes 4305950 10194950 8353950 8062950 3915150 less taxes 1507082.5 3568232.5 2923882.5 2822033 1370303 Net Income 2798867.5 6626717.5 5430067.5 5240918 2544848 add depreciation 4930050 8449050 6034050 4309050 3080850 Cash flow after taxes 7728917.5 15075767.5 11464118 9549968 5625698 add NWC 4966400 3259200 -1474400 5742400 12493600 Net operating cash flow 2762517.5 11816567.5 12938518 3807568 18119298 add salvage value after taxes 6268933 Net cash flow after taxes 2762517.5 11816567.5 12938518 3807568 24388230 Year Cash flow PVIFat 12% PV 0 -34500000 1 -34500000 1 2762517.5 0.892857143 2466533.5 2 11816568 0.797193878 9420095.3 3 12938518 0.711780248 9209381.2 4 3807567.5 0.635518078 2419778 5 24388230 0.567426856 13838537 NPV 2854324.6 Still the NPV is positive even the quantity sold is 20% less than as expected. Keeping in view the abaove analysis, the healthy NPV and good IRR suggests that the project should be accepted, as the project has the ability ot absorb the change in sales in worse conditions. Definitely it would have affected the deicsion if the profit lost from the lost sales, present value is more than the NPV of the project, if the present vlaue of lost profit form lost slaes is lwer than the NPV of the project, the project could have been accepted otherwise not.Related Questions
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