Conch Republic Electronics is a midsized electronics manufacturer located in Key West, FL. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was first founded over 70 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. Jay McCanless, a recent MBA graduate has been hired by the company in its finance department.
One of the major revenue-producing items manufactured by Conch Republic is a Personal Digital Assistant. Conch Republic currently has one PDA model on the market and sales have been excellent. The PDA 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 items, technology changes rapidly, and the current PDA has limited features in comparison to newer models. Conch Republic spent $750K to develop a prototype for a new PDA that has all the features of the existing one, but adds new features such as cell phone capability. The company has spent a further $200,00 for a marketing study to determine the expected sales figures for the new PDA.
Conch Republic can manufacture the new PDA for $215 each in variable costs. Fixed costs for the operations are estimated to run $4.3M per year. The estimated sales volume is 65,000, 82,000, 108,000, 94,000 and 57,000 per year for the next five years respectively. The unit price of the new PDA will be $500. The necessary equipment can be purchased for $32.5M and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $3.5M.
Net working capital for the PDAs will be 20% of sales and will occur with the timing of the cash flows for the year (ie there is not initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first years sales. Conch Republic has a 35% corporate tax rate and 12% required return. Shelly has asked Jay to prepare a written report that answers the following question.
1. What is the payback period of the project?
2. What is the profitability index of the project?
3. What is the IRR of the project?
4. What is the NPV of the project?
5. How sensitive is the NPV to changes in the price of the new PDA?
6. How sensitive is the NPV to changes in the quantity sold?
7. Should Conch Republic produce the new PDA?
8. Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?