Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelly Counts, who inherited the company. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent finance graduate, has been hired by the companys finance department. One of the major revenue-producing items manufactured by Conch Republic is a smartphone. 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 tropical colors and its preprogrammed to play music. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing smartphone but adds new features such as WiFi tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smartphone. Conch Republic can manufacture the new smartphones for $220 each in variable cost for the first year and then it will grow at 4% per year for the following four years. Fixed costs for the operation are estimated to run $6.4 million per year. The estimated sales volume is 100,000 for the first year and then it will grow at 10% per year for the following four years. The unit price of the new smartphone will be $535 for the first year and then it will grow at 3% per year for the following four years. The necessary equipment can be purchased for $43.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.5 million. Net working capital for the smartphone will be 20% of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first years sales. The investment in NWC will be fully recovered at the end of the project. Conch Republic has a 21% corporate tax rate. Conch Republic has 1.5 million shares of common stock outstanding, which is priced at $108 per share. The stock beta is estimated at 2.5. The risk-free rate is 5% and the market risk premium is 7%. In addition, the company has 50,000 bonds outstanding with annual coupon rate of 9%, 20 years to maturity, and the price at 120% of its par value. The bond pays coupon semiannually and the par value of the bond is $1,000. Suppose that the risk level of this project is comparable with

the risk level of the overall firm, so the weighted average cost of capital of the firm is the appropriate discount rate for this project.

1. Complete an NPV analysis on the best and worst-case scenarios.

Best scenario: The unit price of the new smartphone will be $575 for the first year and then it will grow at 3% per year for the following four years. The variable cost of the new smartphone will be $200 each and then it will grow at 4% per year for the following four years. Worst scenario: The unit price of the new smartphone will be $420 for the first year and then it will grow at 3% per year for the following four years. The variable cost of new smartphone will be $260 each and then it will grow at 4% per year for the following four years. You believe that there is 50% chance to be the base scenario, 30% of chance to be the best scenario, and 20% of the chance to be the worst scenario. What is the expected NPV of the new smartphone?