Conch Republic Electronics is a midsized electronics manufacturer located in Key
ID: 2741759 • 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. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company's 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 smart phone 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 phones for $215 each in variable costs. Fixed costs for the operation are estimated to run $6.1 million per year. The estimated sales volume is 155,000, 165,000, 125,000, 95,000, and 75,000 per year for the next five years, respectively. The unit price of the new smart phone will be $520. The necessary equipment can be purchased for $40.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.1 million. As previously stated, Conch Republic currently manufactures a smart phone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smart phone, sales will be 95,000 units and 65,000 units for the next two years, respectively. The price of the existing smart phone is $380 per unit, with variable costs of $145 each and fixed costs of $4.3 million per year. If Conch Republic does introduce the new smart phone, sales of the existing smart phone will fall by 30,000 units per year, and the price of the existing units will have to be lowered to $210 each. 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; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year's sales. Conch Republic has a 35 percent corporate tax rate and a required return of 12 percent. Shelley has asked Jay to prepare a report that answers the following questions.
1. What is/are the sunk cost(s) for this new frozen premium stir fry meal project? Briefly explain. You have to tell what sunk cost is and the amount of the total sunk cost(s). In addition, you have to advise HF on how to handle such cost(s).
2. What are the cash flows of the project for each year?
3. What is the payback period of the project? Should it be accepted if HF requires a payback of 4 years for all projects?
4. What is the PI (profitability index) of the project?
5. What is the IRR (internal rate of return) of the project?
6. What is the NPV (net present value) of the project?
7. Should the project be accepted based on PI, IRR and NPV? Briefly explain
Explanation / Answer
Volume
Doller
Variable
Fixed
Expected
Loss on existing operation
Net
Year
Sales
Sale
Cost
Cost
Income
Sale
V.Cost
Net Loss
Cashinflow
1
155000
80600000
33325000
6100000
41175000
11400000
4350000
7050000
34125000
2
165000
85800000
35475000
6100000
44225000
11400000
4350000
7050000
37175000
3
125000
65000000
26875000
6100000
32025000
32025000
4
95000
49400000
20425000
6100000
22875000
22875000
5
75000
39000000
16125000
6100000
16775000
16775000
Working
Cashflow
Net Cash
Payback
Payback
Year
Cashflows
Capital
Working Capital
flows
Amount
year
1
34125000
-16120000
-16120000
18005000
18005000
1
2
37175000
-17160000
-1040000
36135000
22495000
0.61
3
32025000
-13000000
4160000
36185000
4
22875000
-9880000
3120000
25995000
5
16775000
-7800000
2080000
18855000
Total
142975000
-63960000
-7800000
135175000
40500000
1.61
Prohect Payback period = 1.61 year
PV factor
Present
Year
Cashflows
at 12%
Value
0
-40500000
1
-40500000
1
18005000
0.8928571
16075893
2
36135000
0.7971939
28806601
3
36185000
0.7117802
25755768
4
25995000
0.6355181
16520292
5
18855000
0.5674269
10698833
Total
94675000
57357388
Profitability Index = 57,357,388/40,500,000 = 1.42
Present Value Factor at
Year
Cashflows
58%
59.00%
59.07%
60.00%
61.00%
62.00%
0
-40500000
-40500000
-40500000
-40500000
-4.1E+07
-4.1E+07
-40500000
1
18005000
11395570
11323899
11318769
11253125
11183230
11114197.5
2
36135000
14474844
14293343
14280394
14115234
13940434
13768861.5
3
36185000
9173970
9001962.6
8989732.9
8834229
8670636
8511057.67
4
25995000
4171204.4
4067254.3
4059888.5
3966522
3868889
3774242.18
5
18855000
1914878
1855414.4
1851215.1
1798153
1742999
1689862.87
Total
94675000
630465.79
41873.436
-0.250243
-532737
-1093811
-1641778.3
IRR of the project = 59.07%
Net Present Value (NPV) = $57,357,388
Volume
Doller
Variable
Fixed
Expected
Loss on existing operation
Net
Year
Sales
Sale
Cost
Cost
Income
Sale
V.Cost
Net Loss
Cashinflow
1
155000
80600000
33325000
6100000
41175000
11400000
4350000
7050000
34125000
2
165000
85800000
35475000
6100000
44225000
11400000
4350000
7050000
37175000
3
125000
65000000
26875000
6100000
32025000
32025000
4
95000
49400000
20425000
6100000
22875000
22875000
5
75000
39000000
16125000
6100000
16775000
16775000
Working
Cashflow
Net Cash
Payback
Payback
Year
Cashflows
Capital
Working Capital
flows
Amount
year
1
34125000
-16120000
-16120000
18005000
18005000
1
2
37175000
-17160000
-1040000
36135000
22495000
0.61
3
32025000
-13000000
4160000
36185000
4
22875000
-9880000
3120000
25995000
5
16775000
-7800000
2080000
18855000
Total
142975000
-63960000
-7800000
135175000
40500000
1.61
Prohect Payback period = 1.61 year
PV factor
Present
Year
Cashflows
at 12%
Value
0
-40500000
1
-40500000
1
18005000
0.8928571
16075893
2
36135000
0.7971939
28806601
3
36185000
0.7117802
25755768
4
25995000
0.6355181
16520292
5
18855000
0.5674269
10698833
Total
94675000
57357388
Profitability Index = 57,357,388/40,500,000 = 1.42
Present Value Factor at
Year
Cashflows
58%
59.00%
59.07%
60.00%
61.00%
62.00%
0
-40500000
-40500000
-40500000
-40500000
-4.1E+07
-4.1E+07
-40500000
1
18005000
11395570
11323899
11318769
11253125
11183230
11114197.5
2
36135000
14474844
14293343
14280394
14115234
13940434
13768861.5
3
36185000
9173970
9001962.6
8989732.9
8834229
8670636
8511057.67
4
25995000
4171204.4
4067254.3
4059888.5
3966522
3868889
3774242.18
5
18855000
1914878
1855414.4
1851215.1
1798153
1742999
1689862.87
Total
94675000
630465.79
41873.436
-0.250243
-532737
-1093811
-1641778.3
IRR of the project = 59.07%
Net Present Value (NPV) = $57,357,388
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