Capital Budgeting Project
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 household appliances. Over the years, it has expended into manufacturing and is now a reputable manufacturer of various electronic items. You have been hired by the company's finance department. One of the major revenue-producing items manufactured by Conch is a personal digital assistant (PDA).
Conch currently has one PDA model on the market and sales have been excellent. The PDA 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 PDA has limited features in comparison with newer models. Conch has spent $750,000 to develop a prototype for a new PDA that has all the features of the existing PDA but adds new features such as cell phone capability. The company has spent a further $200,000 for a marketing study to determine expected sales figures for the new PDA. Conch can manufacture the new PDA for $155 each in variable costs. Fixed costs for the operation are estimated to run $4.7 million per year. The estimated sales volume is 74,000, 95,000, 125,000, 105,000, and 80,000 per each year for the next five years, respectively. The unit price of the new PDA will be $360.
The necessary equipment can be purchased for $21.5 million and will be depreciated on a seven-year MACRS schedule. It is believed that the value of the equipment in five years will be $4.1 million. As previously stated, Conch currently manufactures a PDA. Production of the existing model is expected to be terminated in two years. If Conch does not introduce the new PDA, sales of the existing model will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing PDA is $290 per unit, with variable costs of $120 each and fixed costs of $1,800,000 per year. If Conch does introduce the new PDA, sales of the existing PDA will fall by 15,000 units per year and the price of the existing units will be lowered to $255 each. Net working capital requirements for the new PDA production and sales will be 20% of sales and will occur with the timing of the cash flows; for example, there is no initial outlay for NWC, but changes in NWC will occur in year 1 with the first year's sales.
In the final year, the NWC balance (if any) will be fully recouped by the company. Conch has a 35% corporate tax rate and a 12% required return.
1. Perform sensitivity analysis on this project.
2. Give an estimated best-case and worst-case NPV.
3. What is the break-even price for the new PDA?