Case Scenario:
Conch Republic Electronics is a midsized electronics manufacturer located in Key West, Florida. The company president is Shelly 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 personal digital assistant (PDA). Conch Republic currently has one PDA model on the market, and sale has 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 item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new PDA that has all the features of the existing PDA 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 $155 each in variable costs. Fixed costs for the operation are estimated to run $4.7 million per year. The estimated sales volume is 74,000, 95,000, 125,000, 105,000, and 80,000 per each year for the next five years, respectively. The unit price of the new PDA will be $360. The necessary equipment can be purchased for $21.5 million and will be depreciated on a 7 year MACRS schedule. It is believed the value of the equipment in 5 years will be $4.1million.
As previously stated, Conch Republic currently manufactures a PDA. Production of the existing model is expected to be terminated in two years. If conch Republic does not introduce the new PDA, sales will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing PDA is $290 per unit, with variable costs of $120 each and fixed costs of $1,800,000 per year. If conch Republic does introduce the new PDA, sales of the existing PDA will fall by 15,000 units per year, and the price of the existing unit will have to be lowered to $255 each. New working capital for the PDAs 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 35 percent corporate tax rate and a 12 percent required return.
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. Assume that the required payback period is 3 years. According to your analysis, would you recommend that Conch Republic accept or reject the project? Explain.
Because of the rapid changes in technology, Shelly was concerned that a competitor could enter the market. This would likely force Conch republic to lower the sales price of its new PDA. For these reasons, she wants to analyze how changes in the price of the new PDA and changes in the quantity sold will affect the NPV of the project.
1. Create graphs of your analysis
2. Is the project more sensitive to changes in price or quantity sold?
3. What is the change in NPV per dollar change in price? Per unit change in quantity?
4. Does your sensitivity analysis affect your recommendation from Part 1? If it does, in what way?
5. How can management use this information? Why is this analysis useful? Why not?