Conch Republic Electronics is a midsized electron- ics manufacturer located in Key West, Florida. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was founded over 70 years ago. Over the years, the company has ex- panded, and it is now a reputable manufacturer of vari- ous 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 manu- factured by Conch Republic is a Personal Digital Assistant (PDA). Conch Republic currently has one PDA model on the market and sales have been excel- lent. 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 item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a proto- type 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 $200,000 for a marketing study to determine the expected sales figures for the new PDA.
Conch Republic can manufacture the new PDA for $185 each in variable costs. Fixed costs for the operation are estimated to run $5.3 million per year. The estimated sales volume is 74,000, 95,000, 125,000, 105,000, and 80,000 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 $38.5 million and will be depre- ciated on a seven-year MACRS schedule. It is be- lieved the value of the equipment in five years will be $5.4 million.
As previously stated, Conch Republic currently manufactures a smart phone. Production of the existing model is expected to be terminated in two years. If Conch Republic does not introduce the new smart phone, sales will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing smart phone is $310 per unit, with variable costs 0f $215 each and fixed costs of $1,800,000 per year. If Conch Republic does introduce the new smart phone, sales of the existing smart phone will fall by 15,000 units per year, and the price of the existing units will have to be lowered to $275 each.
Net working capital for the smart phones will be 20 per- cent of sales and will occur with the timing of the cash flows for the year (i.e., there is no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year%u2019s sales. Conch Republic has a 35 percent cor- porate tax rate and a 12 percent required return.
Shelly has asked Jay to prepare a report that answers the following questions:
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 quan- tity 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?