Reference no: EM132515134

Conch Republic Electronics

CRE is a midsized electronics manufacturer located in Key West, Florida. They are introducing a new Smart Phone to replace their existing Smartphone noted especially for automatically playing Jimmy Buffett songs when turned on.

The CEO has hired Bobby Hatter, a recent Stetson MBA graduate, to provide a report on the feasibility of this new venture. Bobby has documented the following facts:

1. CRE spent $175,000 to develop a prototype of the new phone and then spent $22,000 for a Marketing Study to determine the expected sales figures.
2. The variable cost to manufacture the phone are $352 per phone.
3. Fixed costs are estimated at $80,000 per year.

The phone will sell for $425 each with estimated sales volumes as follows:

YR 1  1500

YR 2   4700

Yr3    5900

Yr4    3200

Yr5    2000

• The equipment to produce the phone will cost $450,000 and will be depreciated on a straight-line basis over the 5-year project life cycle. CRE has a corporate tax rate of 21% and feels that it must earn at least a return of 20% on this project. CRE borrowed $475,000 to fund this project (beginning balance), so after the purchase of the equipment, the remaining balance was in the bank as working capital. Bobby noted that although there was a loss in year 1, the project showed a positive cash flow and he had to explain this to his management of where the $29,500 came from.

Question 1: What should be Boddy's response to management for why there is a positive cash flow in year 1