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. 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 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 spent $750,000 to develop a prototype for a new smart phone that has all the features of the existing smart phone but adds new features such as WiFi tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smart phone.
Conch Republic can manufacture the new smart phones 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 smart phone will be $480. The necessary equipment can be purchased for $38.5 million and will be depreciated on a seven-year MCARS schedule. It is believed 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 of $125 each and fixed cost 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 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.
Shelley has asked Jay to prepare a report that answers the following questions:
• In order to proceed with this project, what are issues to be considered and metrics to be generated? (use no more than 250 words)
• Using the data presented in the case, specifically show how a decision maker analyzes the information so that an appropriate decision can be made concerning the project? (organize analysis in 1 page)
• Having made the calculation, please reflect on limitations and issues that need further thought and analysis. (no more than 150 words)
• What is the overall recommendation? (no more than 100 words)