Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The com- pany president is Shelly Couts, who inherited the com- pany. The company originally repaired radios and other household appliances when it was founded more than 70 years ago. Over the years, the company has ex- panded, and it is now a reputable manufacturer of vari- ous specialty electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company in its fi- nance department.

One of the major revenue-producing items manu- factured by Conch Republic is a smartphone. Conch Re- public 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 tropical colors and is preprogrammed to play Jimmy Buffett mu- sic. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Re- public spent $1.2 million to develop a prototype for a new smartphone that has all the features of the existing one but adds new features such as Wifi tethering.

company has spent a further $250,000 for a marketing study to determine the expected sales figures for the new smartphone.

Conch Republic can manufacture the new smart- phone for $210 each in variable costs. Fixed costs for the operation are estimated to run $5.3 million per year. The estimated sales volumes are 64,000, 106,000, 87,000, 78,000, and 54,000 per year for each of the next five years, respectively. The unit price of the new smartphone will be $515. The necessary equipment can be purchased for $38.5 million and will be depreci- ated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $5.8 million.

Net working capital for the smartphones 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 thus will occur first in Year 1 with the first years sales. Conch Republic has a 22 percent corporate tax rate and a required return of 12 percent.

What is the profitability index of the project?

b. What is the IRR of the project?

c. What is the NPV of the project?

d. How sensitive is the NPV to changes in the price of the new smartphone? Construct a

one-way data table to help you.

e. How sensitive is the NPV to changes in the quantity sold?

Master it! Solution Equipment Pretax salvage value R&D Marketing study $ $ $ 38,500,000 5,800,000 1,200,000 250,000 Year 3 87,000 Year 4 78,000 Year 5 54,000 Sales (units) Sales of old smartphone Lost sales Depreciation rate Year 1 64,000 80,000 15,000 14.29% Year 2 106,000 60,000 15,000 24.49% 17.49% 12.49% 8.93% S S $ Price VC IFC Tax rate NWC percentage Required return 515 210 5,300,000 22% 20% 12% Year 1 Year 2 Year 3 Year 4 Year 5 Sales VC Fixed costs Dep EBT Tax NI +Dep OCF NWC Beg End NWCCF Net CF Salade