Question

Can you also show how you calculated the answers? Mostly stuck on the answer to NWC and how to estimate cash flows (and everything after that)

Conch Republic Electronics 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 more than 70 years ago. Over the years, the company has expanded, and it is now a reputable 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 smartphone. Conch Republic currently has one smartphone model on the market and sales have been excellent. The smartphone 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 smartphone has limited features in comparison with newer models. Conch Republic spent $1.2 million to develop a prototype for a new smartphone that has all the features of the existing one but adds new features such as Wifi tethering. The company has spent a further $250,000 for a marketing study to determine the expected sales figures for the new smartphone. Conch Republic can manufacture the new smartphone for $210 each in variable costs. Fixed costs for the operation are estimated to run $5.3 million per year. The estimated sales volumes are 64,000, 106,000, 87,000, 78,000, and 54,000 per year for each of the next five years, respectively. The unit price of the new smartphone will be $515. The necessary equipment can be purchased for $38.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $5.8 million. Net working capital for the smartphones 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 thus will occur first in Year 1 with the first year's sales. Conch Republic has a 22 percent corporate tax rate and a required return of 12 percent. Shelly has asked Jay to prepare a report that answers the following questions: QUESTIONS 1. What is the payback period of the project? 2. What is the profitability index of the project? 3. What is the IRR of the project? 4. What is the NPV of the project? 5. How sensitive is the NPV to changes in the price of the new smartphone? 6. How sensitive is the NPV to changes in the quantity sold? 7. Should Conch Republic produce the new smartphone? 8. Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?

Answer 1

1). Payback period = 2.698 years

2). Profitability index = 1.515

3). IRR = 28.07%

4). NPV = 19,845,464.30

All calculations show in the table below:

2 Formula Equipment cost 38500000 TR = u*p VC=u*vc Year (n) Initial investment (11) Unit sales Price/unit Variable cost/unit Total revenues Total variable cost Fixed cost MACRS depreciation rates Depreciation EBIT (or operating income) Tax @ 22% After-tax operating income Add back: Depreciation Operating cash flow 640001 515| 210 32960000 13440000 5300000 14.29% 5501650 8718350 1918037 68003131 5501650 12301963 106000 87000 78000 54000 515 515 515 515 210 210 210 210 5459000044805000| 4017000027810000 22260000 18270000 16380000 11340000 5300000 5300000 5300000 5300000 24.49% 17.49% 12.49% 8.93% 9428650 6733650 4808650 3438050 1760135014501350 13681350 7731950 3872297 3190297 3009897 1701029 13729053 11311053 10671453 6030921 9428650 6733650 4808650 3438050 23157703 1804470315480103 9468971 D = 11*r T= 22%*EBIT NI = EBIT-T OCF = NI+D

Free Cash Flow calculation: NWC = 20%*TR Net Working Capital 659200010918000 89610008034000 5562000 NWCn-1 - NWCn; Recovery of entire NWC in year 5 SV ol -6592000 -4326000 19570001 927000 Increase in NWC Salvage value 8034000 5800000 BV = || - (Total dep. Over 5 yrs) Book value 8589350 ASV = SV - 22%*(SV-BV) After-tax salvage value 6413657 5709963 0.893 5098181 1883170320001703 0.797 0.712 15012518 14236817| 16407103 0 .636 10427011 23916628 0.567| 13570937 FCF = OCF - Increase in NWC + ASV - 11 Free Cash Flow 1/(1+12%)^n Discount factor @ 12% FCF*Discount factor PV of FCF Sum of all PVs NPV Using IRR function with FCFS IRR (Sum of all PVs from Yr 1 to Yr 5)/11 Profitability index -38500000 1.000 -38500000 19845464 28.07% 1.515

5).

5). Sensitivity of NPV to change in price of the smartphone can be found by varying the price to get the new NPV.

NPV = 19,845,464 when price per unit = $515

NPV = 18,765,838 when price per unit = $510

Sensitivity of NPV to price = (new NPV - old NPV)/(new price - old price) = (18,765,838 - 19,845,464)/(510-515) = 215,925.32

6). Sensitivity of NPV to the quantity sold:

NPV = 19,845,464 when original quantities are sold

NPV = 20,669,521 when original quantities per year are increased by 1,000

Sensitivity of NPV to quantity = (new NPV - old NPV)/change in number of units sold per year = (20,669,521-19,845,464)/1,000 = 824.06

7). Since NPV is positive, the project is profit making, so Conch Republic should produce the new smartphone.

8). If other models register lower sales due to introduction of the new model then the loss is sales will be part of the NPV analysis.