Task 1: Capital Budgeting

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. Recently, you have been hired by the company's finance department. One of the major revenue-producing items manufactured by Conch Republic is a smart phone. Conch Republic currently has one smart phone model on the market, and sales have been excellent. The smart phone 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 smart phone has limited features in comparison with newer models. Conch Republic can manufacture the new smart phones for $300 each in variable costs. Fixed costs for the operation are estimated to run $4.3 million per year. The estimated sales volume is 75,000, 95,000, 125,000, 130,000, and 140,000 per year for the next five years, respectively. The unit price of the new smart phone will be $650. The necessary equipment can be purchased for $61 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $3.4 million. Shelley has asked you to prepare a report that answers the following questions.

Questions:

1. What is the payback period (PBP) of the project? Based on your analysis of PBP, should the company accept the smart phone project if the required payback period is 3 years?

2. What is the IRR of the project? Based on your analysis of IRR, should the company accept the smart phone project?

3. What is the NPV of the project? Based on your analysis of NPV, should the company accept the smart phone project?

4. At what price would Conch Republic Electronics be indifferent to accepting the project?

Task 2: Scenario Analysis Shelley believes that the unit sales, variable costs and equipment cost projections are accurate to 20%.

Questions:

5. What is the best case NPV, IRR and PBP of the project?

6. What is the worst case NPV, IRR and PBP of the project? Would you still accept the project under this scenario?

Task 3: Sensitivity Analysis

Shelley was not convinced the sales projections presented by the market research firm were entirely accurate. Additionally, because of rapid changes in technology, she was concerned that a competitor could enter the market. This would likely force Conch Republic to lower the sales price of its new smart phone. Moreover, technological advancement may cause unexpected changes in fixed costs (new computers etc.). Due to the unforeseeable circumstances, she has asked you to analyze how changes in the price of the new smart phone and fixed cost will affect the NPV of the project.

Questions:

7. How sensitive is the NPV to changes in the price of the new smart phone?

8. How sensitive is the NPV to changes in the fixed costs?

9. Construct a two-way data table to analyze sensitivity of NPV to price and fixed costs.

10. Based on your analysis, NPV is more sensitive to changes in which variable: price or fixed costs?