Conch Republic Electronics is a mid-sized electronicsmanufacturer located in Key West, Florida. The company president isShelley Couts, who inherited the company. When it was founded over70 years ago, the company originally repaired radios and otherhousehold appliances. Over the years, the company expanded intomanufacturing and is now a reputable manufacturer of variouselectronic items. Jay McCanless, a recent MBA graduate, has beenhired by the company's finance department.
One of the major revenue-producing items manufactured by ConchRepublic is a smart phone. 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 tropicalcolors and is preprogrammed to play Jimmy Buffett music. However,as with any electronic item, technology changes rapidly, and thecurrent smart phone has limited features in comparison with newermodels. Conch Republic spent $750,000 to develop a prototype for anew smart phone that has all the features of the existing smartphone but adds new features such as WiFi tethering. The company hasspent a further $200,000 for a marketing study to determine theexpected sales figures for the new smart phone.
Conch Republic can manufacture the new smart phones for $185variable costs. Fixed costs for the operation are estimated to run$5.3 million per year. The estimated sales volume is 74,000,95,000, 125,000, 105,000, 80,000 per year for the next five years,respectively. The unit price of the new smart phone will be $480.The necessary equipment can be purchased for $38.5 million and willbe depreciated on a seven-year MACRS schedule. It is believed thevalue of the equipment in five years will be $5.4 million.
As previously stated, Conch Republic currently manufactures asmart phone. Production of the existing model is expected to beterminated in two years. If Conch Republic does not introduce thenew smart phone, sales will be 80,000 units and 60,000 units forthe next two years, respectively. The price of the existing smartphone is $310 per unit, with variable costs of $125 each and fixedcosts at $1.8 million per year. If Conch Republic does introducethe new smart phone, sales of existing smart phones will fall by15,000 units per year, and the price of the existing units willhave to be lowered to $275 each. Net working capital for the smartphones will be 20 percent of sales and will occur with the timingof the cash flows for the year; for example, there is no initialoutlay for NWC, but changes in NWC will first occur in Year 1 withthe first years' sales. Conch Republic has a 35 percent corporatetax rate and a 12 percent required return.
Shelley has asked Jay to prepare a report that answers thefollowing 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?
