Conch Republic Electronics, Part $2$

Shelley Couts, the owner of Conch Republic Electronics, has received the capital budgeting analysis from Jay McCanless for the new smartphone the company is considering. Shelley is pleased with the results, but she still has concerns about the new smartphone. Conch Republic has used a small market research firm for the past $20$ years, but recently the founder of that firm has retired. Because of this, Shelley is not convinced the sales projections presented by the market research firm are entirely accurate. Additionally, because of rapid changes in technology, she is concerned that a competitor may enter the market. This would likely force Conch Republic to lower the sales price of

its new smartphone. For these reasons, she has asked Jay to analyze how changes in the price of the new smartphone and changes in the quantity sold will affect the NPV of the project.

Shelley has asked Jay to prepare a memo answering the following questions.

QUESTIONS

How sensitive is the NPV to changes in the price of the new smartphone?

How sensitive is the NPV to changes in the quantity sold of the new smartphone?

MINICASE

Conch Republic Electronics, Part $1$

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, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company's 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 is preprogrammed to play Jimmy Buffett 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 $$950,000$ to develop a prototype for a new smartphone that has all the features of the existing smartphone but adds new features such as WiFi tethering. The company has spent a further $$250,000$ for a marketing study to determine the expected sales figures for the new smartphone.

Conch Republic can manufacture the new smartphones for $$245$ each in variable costs. Fixed costs for the operation are est mated to run $$6\mathrm{.}9$ million per year. The estimated sales volUre is $160,000,170,000,130,000,105,000,$ and $80,000$ per yar for the next five years, respectively. The unit price of the L$.$w smartphone will be $$575.$ The necessary equipment can

be purchased for $$49\mathrm{.}5$ million and will be depreciated on a seven$-$year MACRS schedule. It is believed the value of the equipment in five years will be $$6\mathrm{.}8$ million.

As previously stated, Conch Republic currently manufactures a smartphone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smartphone, sales will be $95,000$ units and $65,000$ units for the next two years, respectively. The price of the existing smartphone is $$435$ per unit, with variable costs of $$155$ each and fixed costs of $$4\mathrm{.}3$ million per year. If Conch Republic does introduce the new smartphone, sales of the existing smartphone will fall by $30,000$ units per year, and the price of the existing units will have to be lowered to $$235$ each. 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; for example, there is no initial outlay for NWC$,$ but changes in NWC will first occur in Year $1$ with the first year's sales. Conch Republic has a $21$ percent corporate tax rate and a required return of $12$ percent.

Shelley has asked Jay to prepare a report that answers the following questions.

QUESTIONS

What is the payback period of the project?

What is the profitability index of the project?

What is the IRR of the project?

What is the NPV of the project?