Problem -
Conch Republic Electronics is a mid-sized 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 Personal Digital Assistant (PDA). Conch Republic 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 Buffet music. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new PDA that has all the features of the existing one, but adds new features such as cell phone capability. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new PDA.
Conch Republic 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 7-year MACRS schedule. It is believed the value of the equipment in five years will be $4.1 million.
As previously stated. Conch Republic currently manufactured a PDA. Production of the existing model is expected to be terminated in two years. If conch Republic does not introduce the new PDA, sales 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 cost of $1,800,000 per year. If conch Republic 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 have to be lowered to $255 each.
Net working capital for the PDAs 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 will thus first occur in Year 1 with the first year's sales. Conch Republic has a 35 percent corporate tax rate and a 12 percent required return.
Shelly has asked Jay to prepare a report that answers the following questions:
1. What is the payback period of the project?
2. What is profitability index of the project?
3. What is IRR of the project?
4. What is the NPV of the project?