Chapter 9, case Conch Republic Electronics , from essential of Corporate finance

Question

Chapter 9, case Conch Republic Electronics , from essential of Corporate finance edition8.

The company sells electronics such as smart phones which has being very successful sellers. However, as with any electronic item, technology changes rapidly. So the company spent $750,000 to develope a prototype for a new smart phone with new features. The company has spent a further $200,000 for a marketing study to determine the expected sales in the new item. They can manufacture the new phone for $205 each in variable cost. Fixed cost are stimated $5.1 million per year. The stimated sales volume is 64,000, 106,000, 87,000, 78,000, and 54,00 per year for the next five years. The unit price will be $485. The necessary equipment can be purchase for $34.5 million and will be depreciated on a 7 year MACRS schedule. The value of the equitment in 5 years will be $5.5 million. NWC for the new phone will be 20% of sales and will occur with the timing of the cash flow for the year. Changes in the NWC will occur in the year 1 with the first's year sale. Conch Republican has 35% corporate tax rate and a requirement return of 12%.

Questios: 4) What is the Net Present Value for the project?

5) How sensitive is the NPV to changes in the price of the new smart phone?

Explanation / Answer

Answer (a) Cash Flows Associated with Project Year 0 1 2 3 4 5 Initial Expenses on Development of Prototype -750000 Cost of Marketing Study -200000 Cost of Equipment -34500000 Operating Cash Flows 9664020 18127620 13969620 11767620 7244340 Increase in working capital -6208000 -4074000 -4365000 -3201000 -2037000 Salvage Value 5500000 Total Cash Flows -35450000 3456020 14053620 9604620 8566620 10707340 Discount factor (1/1.12^year) 1 0.892857 0.797194 0.71178 0.635518 0.567427 Discounted Cash Flows -35450000 3085732 11203460 6836379 5444242 6075632 Net Present Value -2804555 Calculation of Cash Flows Year 1 2 3 4 5 Expected Sales 31040000 51410000 42195000 37830000 26190000 Variable Costs 13120000 21730000 17835000 15990000 11070000 Fixed Costs 5100000 5100000 5100000 5100000 5100000 Depreciation 4930050 8449050 6034050 4309050 3080850 EBT 7889950 16130950 13225950 12430950 6939150 Tax 3155980 6452380 5290380 4972380 2775660 EAT 4733970 9678570 7935570 7458570 4163490 Operating Cash Flows (EAT+Depreciation) 9664020 18127620 13969620 11767620 7244340 Increase in working capital 6208000 4074000 4365000 3201000 2037000 Answer (b) A 5% increase in sales price of the phones Calculation of Cash Flows Year 1 2 3 4 5 Expected Sales 32592000 53980500 44304750 39721500 27499500 Variable Costs 13120000 21730000 17835000 15990000 11070000 Fixed Costs 5100000 5100000 5100000 5100000 5100000 Depreciation 4930050 8449050 6034050 4309050 3080850 EBT 9441950 18701450 15335700 14322450 8248650 Tax 3776780 7480580 6134280 5728980 3299460 EAT 5665170 11220870 9201420 8593470 4949190 Revised operating cash flows 10595220 19669920 15235470 12902520 8030040 revised Increase in working capital 6518400 4277700 4583250 3361050 2138850 Revised Total Cash Flows -35450000 4076820 15392220 10652220 9541470 11391190 Discount Factor 1 0.892857 0.797194 0.71178 0.635518 0.567427 Discounted Flows -35450000 3640018 12270584 7582040 6063777 6463667 Revised Net Present Value 570085 Change in NPV (%) 120.3271 Revised cash flows from year 1 onwards is Total Cash flows in (a) - Operating cash flow + increase in WC + revised operating cash flow - revised inc in wc In case there is a 5% Decrease in Sales Price Calculation of Cash Flows Year 1 2 3 4 5 Expected Sales 29488000 48839500 40085250 35938500 24880500 Variable Costs 13120000 21730000 17835000 15990000 11070000 Fixed Costs 5100000 5100000 5100000 5100000 5100000 Depreciation 4930050 8449050 6034050 4309050 3080850 EBT 6337950 13560450 11116200 10539450 5629650 Tax 2535180 5424180 4446480 4215780 2251860 EAT 3802770 8136270 6669720 6323670 3377790 Revised operating cash flows 8732820 16585320 12703770 10632720 6458640 revised Increase in working capital 5897600 3870300 4146750 3040950 1935150 Revised Total Cash Flows -35450000 2835220 12715020 8557020 7591770 10023490 Discount Factor 1 0.892857 0.797194 0.71178 0.635518 0.567427 Discounted Flows -35450000 2531446 10136336 6090718 4824707 5687597 Revised Net Present Value -6179195 Change in NPV (%) 120.3271 1 2 3 4 5 Sales in Units 64000 106000 87000 78000 54000 Depreciation rates (MACRS 7 years) 0.1429 0.2449 0.1749 0.1249 0.0893 Unit Price 485 Variable Cost 205 Fixed Cost 5100000 Cost of equipment 34500000 Salvage Value 5500000 NWC 20% of sales Corporate Tax Rate 40% Required Rate of Return 12%

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