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Running head: CONCH REPUBLIC ELECTRONICS, PART 1 M6A1 Mini Case Conch Republic Electronics, Part 1 Joe D. Clayton Instructor: Professor Naomi Venters Excelsior College June 12, 2016 1 CONCH REPUBLIC ELECTRONICS, PART 1 2 Conch Republic Electronics, Part 1 Introduction After studying this week's assignment on capital budgeting, I have assumed the responsibilities as an MBA graduate to analyze with the ability to apply cash flow models for evaluating capital decisions within Conch Republic Electronics. As technology changes constantly the decision has to be made on whether or not it's the right financial move to make on manufacturing a new smart phone or not in the near future for this company. What is the payback period of the project? Information provided: Initial Cost =$750,000 Cost of Marketing =$200,000 Price per unit =$480 Variable cost per unit =$185 Fixed cost =$5,300,000 Equipment =$38,500,000 Project life =5 Yrs Net Working capital =20% Estimated sales by units =74,000; 95,000; 125,000; 105,000; and 80,000 per yr for the next 5 yrs. Sales 1st yr = new sales - lost sales - lost revenue = (74,000x$480) -(15,000x$310)- [(80,000-15,000) x ($310-$275)] = $28,595,000 Sales 2nd yr = (95,000x480) = (15,000x310)- [(60,000-15,000) x (310-275)] = $39,375,000 Sales 3rd yr = New Sales = (125,000x$480) =$60,000,000 Sales 4th yr = (105,000x480) =$50,400,000 Sales 5th yr = (80,000x480) CONCH REPUBLIC ELECTRONICS, PART 1 =$38,400,000 Variable cost 1 yr = Variable cost new product - variable cost lost sales = ($185x74, 000) - (125x15, 000) =$13,690,000-1,875,000 = $11,815,000 2 yr = ($185x95,000) -($125x15, 000) = 17,575,000 - 1,875,000 = $15,700,000 Variable cost 3 yr = Variable cost new product = (185x125, 000) = $23,125,000 4 yr = (185x74, 000) = $13,690,000 5 yr = (185x 80,000) = $14,800,000 Equipment depreciation using the seven year MACRS schedule 1st yr = 14.29% x $38,500,000 = .1429 x $38,500,000 = $5,501,650 2nd yr = 24.49% x $38,500,000 = 0.2449 x $38,500,000 =$9,428,650 3rd yr = 17.49% x$38,500,000 = 0.1749 x $38,500,000 =$6,733,650 4th yr = 12.49% x $38,500,000 = 0.1249 x$38,500,000= $4,808,650 5th yr = 8.93% x $38,500,000 = .0893 x $38,500,000 = $3,438,050 Operating cash flow (OCF) = Net income + depreciation= (S-VC-FC-D) x (1-T) + D S= Sales; VC= Variable cost; FC = Fixed cost; D= Depreciation; T= Tax rate OCF 1st yr = (28,595,000-11,815,000-5,300,000-5,501,650) x (1-0.35) + 5,501,650 = $9,387,577.50 OCF 2nd yr = (39,375,000-15,700,000-5,300,000-9,428,640) x (1-0.35) + 9,428,640 =$15,243,777.50 3 CONCH REPUBLIC ELECTRONICS, PART 1 OCF 3rd yr = (60,000,000-23,125,000-5,300,000-6,733,650) x (1-0.35) + 6,733,650 =$22,880,572.50 OCF 4th yr = (50,400,000-13,690,000-5,300,000-4,808,650) x (1-0.35) + 4,808,650 =$20,848,277.50 OCF 5th yr = (38,400,000-14,800,000-5,300,000-3,438,050) x (1-0.35) + 3,438,050 =$19,503,317.50 Net Working Capital at 20% of total sales NWC 1st yr = beginning NWC - 20%xSales = $-0.2x$28,595,000 =-$5,719,000 NWC 2nd yr = $5,719,000-.2x$60,000,000 =-$2,156,000 NWC 3rd yr = $7,875,000-.2x$60,000,000 =-$-4,125,000 NWC 4th yr = $12,000,000-.2x$50,400,000 =$1,920,000 NWC 5th yr = $10,080,000-.2x$38,400,000 =$2,400,000 Operating Cash Flows (OCF) and the NWC Total cash flow of the year = OCF of the year + NWC of the year Cash flow of 1st yr = 9,387,577.50-5,719,000 = $3,668,577.50 2nd yr = 15,243,777.50-2,156,000 = $13,087,777.50 3rd yr = 22,880,572.50-4,125,000 =$18,755,527.50 4th yr = 18,371,777.50+ 1,920,000 =$20,291,777.50 5th yr = 13,098,317.50+2,400,000 = $15,498,317.50 4 CONCH REPUBLIC ELECTRONICS, PART 1 5 Calculating payback period Initial cost = $38,500,000 Cash flow first 3 yrs = $3,668,577.50+ 13,087,777.50+ 18,755,577.50 = $35,511,932.5 Payback period = 3+ remaining cash flow CF yr 4 = 3+ 38,500,000 - 35,511,932.5 20,291,777.50 = 3+ 2,988,067.5 = 3+ .147 = 3.15 20,291,777.50 = 3.15, the payback period which means the company should recuperate their initial cost in about 3 years and 2 months. What is the IRR of the project? NPV = CF0 + CF1 + CF2 + CF3 + CF4 + CF5 1 + IRR (1+IRR)2 (1+IRR)3(1+IRR)4(1+IRR)5 NPV = -38,500,000 + 1,901,078 + 11,565,278 + 20,000,528 + 20,291,778 1 + IRR (1+IRR)2 (1+IRR)3(1+IRR)4 + 20,898,318 (1+IRR)5= 0 So the IRR is 20.8% What is the NPV of the project? NPV = CF0 + CF1 + CF2 + CF3 + CF4 + CF5 1 + r (1+r)2 (1+r)3 (1+r)4 (1+r)5 NPV = -38,500,000 + 1,901,078 + 11,565,278 + 20,000,528 + 20,291,778 1 + .12 (1+.12)2 (1+.12)3(1+.12)4 + 20,898,318(1+.12)5 =-35,500,000 + 1,697,391.07 + 9,219,768.81 + 14,235,980.77 + 12,895,791.76 + 11,858,266.87 = 14,407,199.28 What is the profitability index of the project? Profitability Index = NPV Initial expenditure = 11,407,199 38,500,000 = 29.63% = Profitability index CONCH REPUBLIC ELECTRONICS, PART 1 6 Recommendation/Conclusion Yes, Conch Republic Electronics should produce the new PDA. They should produce it based on the net present value rule stating that a project should be accepted if the net present value is positive and rejected if it is negative (Ross, Westerfield, & Jordan, 2013). Even after assuming the change in sales as well as prices, the company will have positive NPV. However, after considering the lost in sales, the company will still incur profit and have a positive return, thus the company should produce new PDA. NPV is sensitive to changes in price. Positive results are beneficial to the project. Quantity sold impacts NPV because only this project should be accepted if NPV is positive. Conch Republic Electronics are losing sales on other models because of the introduction of the new model would not necessarily affect my analysis because the information focuses and deals with the newer model PDA. CONCH REPUBLIC ELECTRONICS, PART 1 Reference Ross, S. A., Westerfield, R., & Jordan, B. D. (2013). Fundamentals of Corporate Finance (10th ed.). New York, NY: Irwin/McGraw-Hill. 7