Reference no: EM13768885

CAPITAL BUDGETING

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 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 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 pre programmed 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 $500,000 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 $250,000 for a marketing study to determine the expected sales figures for the new smart phone.

Conch Republic can manufacture the new smart phone for $195 each in variable costs. Fixed costs for the operation are estimated to run $4.1 million per year. The estimated sales volume is 89,000, 126,000, 97,000, 87,000, and 64,000 per year for the next five years, respectively. The unit price of the new smart phone will be $450. The necessary equipment can be purchased for $30.5 million and will be depreciated on a seven year MACRS schedule. It is believed the value of the equipment in five years will be 2.5 million

Net working capital for the smart phones will be 15 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 34 percent corporate tax rate and a required return of 13 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. Perform a sensitivity analysis for the price of the new smart phone. Measure the effects on NPV by moving price 5% up and down.

6. Perform a sensitivity analysis for the quantity of phones sold. Measure the effects on NPV by moving quantity 5% up and down.

7. Should Conch Republic produce the new smart phone?

8. Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?