Conch Republic Electronics is a midsized electronics manufacturer located in Key

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 houschold appliances. Over the years, the company sil maintain its main service business o which accounts for about 50 percent of its total revenue. The company also expanded into the business of manufacturing electronic items. You and your team, the Carson College of Business graduates, are hired by the company's finance department to evaluate a new project for the company f repairing household electronics, One of the major revenue-producing items of Conch Republic's manufacture division is a smart phone. Conch Republic currently has one smart phone model on the market, and sales have been excellent. Conch Republic's main competitor on the smart phone market is Apple Inc. (AAPL). Conch Republic's 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 S215 each in variable costs. Fixed costs for the operation are estimated to run S6.1 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 S520. The necessary equipment can be purchased for S40.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be S6.1 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 S380 per unit, with variable costs of S145 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. The company has a target debt to equity ratio of 1 and is currently AA rated. The overall cost of capital of the company is 12 percent.

Explanation / Answer

New Product Year 1 2 3 4 5 Units 155000 165000 125000 95000 75000 Sale Price 520 520 520 520 520 Revenue = Units*Sale Price 80600000 85800000 65000000 49400000 39000000 Lost Sales calculation for existing product Lost Revenue calculation for existing product due to reduction in price to 210 Year 1 2 Discontinued Discontinued Discontinued Year 1 2 Discontinued Discontinued Discontinued Units 30000 30000 Units (95000-35000)= 60000 (60000-35000)= 25000 Price 380 380 Price (380-210)=170 (380-210)=170 11400000 11400000 (60000*170)=10200000 (25000*170)=4250000 Lost Revenue   10200000 4250000 Depreciation Schedule 40500000        34,714,285.71    29,755,102.04    25,504,373.18    21,860,891.30 Depn                 5,785,714.29          4,959,183.67      4,250,728.86      3,643,481.88      3,122,984.47               34,714,285.71        29,755,102.04    25,504,373.18    21,860,891.30    18,737,906.82 Addition              200,000.00          171,428.57          146,938.78 125947.5219                28,571.43            24,489.80            20,991.25            17,992.50              171,428.57          146,938.78          125,947.52          107,955.02 1 2 3 4 5 Income Statement Sales Year 1 Year 2 Year 3 Year 4 Year 5 Units Sold 155000 165000 125000 95000 75000 Sales 80600000 85800000 65000000 49400000 39000000 Lost Sales due to reduction in Units -11400000 -11400000 Lost Sales due to reduction in Price -10200000 -4250000 Net Sales 59000000 70150000 65000000 49400000 39000000 Variable Cost/Unit 215 215 215 215 215 Total Variable Cost on production units 33325000 35475000 26875000 20425000 16125000 Lost Sales VC saved -6450000 -6450000 Total Variable Cost 26875000 29025000 26875000 20425000 16125000 Sales 59000000 70150000 65000000 49400000 39000000 Variable Cost 26875000 29025000 26875000 20425000 16125000 Fixed Cost 6100000 6100000 6100000 6100000 6100000 Depreciation                 5,785,714.29          5,130,612.24      4,397,667.64      3,769,429.40      3,230,939.49 Earning Before Tax (EBT)               20,239,285.71        29,894,387.76    27,627,332.36    19,105,570.60    13,544,060.51 Tax - 35%                 7,083,750.00        10,463,035.71      9,669,566.33      6,686,949.71      4,740,421.18 Net Income (NI)               13,155,535.71        19,431,352.04    17,957,766.03    12,418,620.89      8,803,639.33 Depreciation benefit                 5,785,714.29          5,130,612.24      4,397,667.64      3,769,429.40      3,230,939.49 Operating Cash Flow (OCF)               18,941,250.00        24,561,964.29    22,355,433.67    16,188,050.29    12,034,578.82 Net Working Capital 20% on sales Beginning 0 16120000 17160000 13000000 9880000 End 16120000 17160000 13000000 9880000 0 NWC CF -16120000 -1040000 4160000 3120000 9880000 Net CF                 2,821,250.00        23,521,964.29    26,515,433.67    19,308,050.29    21,914,578.82 Book value of equipment 40500000-5785714-5130612-4397667-3769429-3230939 18185639 40500000 6100000 Tax on Sale of Equipment (BV-MV)*tax rate (18185639-6100000) 12085639 (12085639*0.35)=      4,229,973.65 Cash Flow on Sale of Equipment (61000000+4229973)= 65229973 Hence the Cash flow of the project are Year 0 -40500000 1          2,821,250.00 2        23,521,964.29 3        26,515,433.67 4        19,308,050.29 5        87,144,551.82 Incldue Cash flow of equipment

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