CHAPTER 9
CONCH REPUBLIC ELECTRONICS
This is an in-depth capital budgeting problem. The initial cash outlay at Time 0 is the cost of the new
equipment, $34,500,000. The R&D costs and marketing costs are both sunk costs. The sales each year
are the quantity sold times the price, and the variable costs are the quantity sold times the variable cost
per unit. The pro forma income statement and cash flow will be:
Sales
Year 1
Year 2
Year 3
Year 4
Year 5
Sales
$31,040,000
$51,410,000
$42,195,000
$37,830,000
$26,190,000
VC
13,120,000
21,730,000
17,835,000
15,990,000
11,070,000
Fixed costs
5,100,000
5,100,000
5,100,000
5,100,000
5,100,000
NWC
Beg
$0
$6,208,000
$10,282,000
$8,439,000
$7,566,000
End
6,208,000
10,282,000
8,439,000
7,566,000
0
NWC CF
–$6,208,000
–$4,074,000
$1,843,000
$873,000
$7,566,000
Net CF
$3,850,518
$14,860,168
$16,473,918
$13,262,168
$15,157,298
Depreciation
4,930,050
8,449,050
6,034,050
4,309,050
3,080,850
EBT
$7,889,950
$16,130,950
$13,225,950
$12,430,950
$6,939,150
Tax
2,761,483
5,645,833
4,629,083
4,350,833
2,428,703
$5,128,468
$10,485,118
$8,596,868
$8,080,118
$4,510,448
+ Depreciation
4,930,050
8,449,050
6,034,050
4,309,050
3,080,850
$10,058,518
$18,934,168
$14,630,918
$12,389,168
$7,591,298
So, the cash flows of the project are:
Cash flow
–$34,500,000
1. The payback period is:
Payback period = 2 + ($15,789,315 / $16,473,918)
Payback period = 2.96 years
3. The project IRR is:
IRR: 0 = –$34,500,000 + $3,850,518 / (1 + IRR) + $14,860,168 / (1 + IRR)2
+ $16,473,918 / (1 + IRR)3 + $13,262,168 / (1 + IRR)4 + $21,426,230 / (1 + IRR)5
IRR = 23.80%
1
2
3
4
5
5. Here we want to examine the sensitivity of NPV to changes in the price of the new smartphone. The
price at which the “new” NPV is calculated is irrelevant since the sensitivity will be the same.
Assuming a price of $495, the pro forma cash flows will be:
Sales
Year 1
Year 2
Year 3
Year 4
Year 5
Sales
$31,680,000
$52,470,000
$43,065,000
$38,610,000
$26,730,000
VC
13,120,000
21,730,000
17,835,000
15,990,000
11,070,000
Fixed costs
5,100,000
5,100,000
5,100,000
5,100,000
5,100,000
Net CF
$4,138,518
$15,465,168
$17,077,418
$13,787,168
$15,664,298
BV of equipment = $34,500,000 – 4,930,050 – 8,449,050 – 6,034,050 – 4,309,050 – 3,080,850
BV of equipment = $7,696,950
Taxes on sale of equipment = (BV – MV)(TC) = ($7,696,950 – 5,500,000)(.35) = $768,933
CF on sale of equipment = $5,500,000 + 768,933 = $6,268,933
Depreciation
4,930,050
8,449,050
6,034,050
4,309,050
3,080,850
EBT
$8,529,950
$17,190,950
$14,095,950
$13,210,950
$7,479,150
Tax
2,985,483
6,016,833
4,933,583
4,623,833
2,617,703
$5,544,468
$11,174,118
$9,162,368
$8,587,118
$4,861,448
+ Depreciation
$10,474,518
$19,623,168
$15,196,418
$12,896,168
$7,942,298
NWC
Beg
$6,336,000
$10,494,000
$8,613,000
$7,722,000
End
10,494,000
NWC CF
$1,881,000
$7,722,000
The NPV with this sales price is:
NPV = –$34,500,000 + $4,138,518 / 1.12 + $15,465,168 / 1.122 + $17,077,418 / 1.123 +
$13,787,168 / 1.124 + $21,933,230 / 1.125
NPV = $14,886,708.15
6. Here we want to examine the sensitivity of NPV to changes in the quantity sold. The calculations for
sensitivity to changes in quantity are similar to the original cash flows. The only difference is that we
will change the quantity sold of the new smart phone. We will increase units sold by 100 units per
year. Remember that the quantity we choose is irrelevant: The final answer we want, the sensitivity of
NPV to a one unit per year change in sales, will be the same regardless of the quantity we choose. The
projections with the new quantity are:
Sales
Year 1
Year 2
Year 3
Year 4
Year 5
Sales
$31,088,500
$51,458,500
$42,243,500
$37,878,500
$26,238,500
Fixed costs
Depreciation
EBT
$16,158,950
$13,253,950
$12,458,950
Tax
$10,503,318
+ Depreciation
$10,076,718
$18,952,368
$14,649,118
$12,407,368
$7,609,498
NWC
Beg
$0
$6,217,700
$10,291,700
$8,448,700
$7,575,700
End
6,217,700
10,291,700
8,448,700
7,575,700
0
NWC CF
–$6,217,700
–$4,074,000
$1,843,000
$873,000
$7,575,700
Net CF
$3,859,018
$14,878,368
$16,492,118
$13,280,368
$15,185,198
So, the cash flows of the project under this quantity assumption are:
Cash flow
–$34,500,000
3,859,018
So, the sensitivity of NPV to units sold is:
ΔNPV/ΔQ = ($13,158,821.46 – 13,096,371.21) / 100
ΔNPV/ΔQ = $624.50
For a one unit per year change in quantity sold of the new smartphone, the NPV of the project changes
$624.50 in the same direction.
2
3
4
5
21,454,130