Conch Republic Electronics
Spent $750.00 to develop a prototype (or Model) for a new PDA
Spent an additional $200,000 for marketing study to determine the expected sales.
Can manufacture the new PDA with variable cost for $86.00 each.
Fixed Costs for the operation are estimated at $3 million per year.
Unit Price $250.00 each
Necessary equipment to produce the PDA will cost $15 million, with depreciation for 7 years MACRS schedule.
It is believed that this equipment after 5 years will be worth $3 million.
NWC will be 20% of Sales
Changes in NWC will occur in Year 1, with the first year sales.
There is no initial outlay for NWC.
Conch Republic Corporate Tax Rate is 35% and has a 12% required return.
Estimated Sales Volumes:
NWC 20%
Year Est.Sales of Sales
1 70,000 14,000
2 80,000 16,000
3 100,000 20,000
4 85,000 17,000
5 75,000 15,000

Prepare pro forma financial statement and Project cash flows.
Calculate NPV, IRR, Payback period, PI

Year 0 1 2 3 4 5
I. Investment Outlay
1. Develop a prototype -750
2. Marketing study -200,000
3. Equipment -15,000,000
4. Total net investment -15,200,750

II. Operating Cashflows over the Project's Life
5. Sales of new PDA ($250 per unit) 17,500,000 20,000,000 25,000,000 21,250,000 18,750,000
6. Variable costs ($86 per unit) 6,020,000 6,880,000 8,600,000 7,310,000 6,450,000
7. Fixed Costs ($3,000,000 per year) 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
8. Depreciation on new equipment 2,143,500 3,673,500 2,623,500 1,873,500 1,339,500
9. Earning before tax 6,336,500 6,446,500 10,776,500 9,066,500 7,960,500
10. Taxes (35%) 2,217,775 2,256,275 3,771,775 3,173,275 2,786,175
11. Projected net operating income 4,118,725 4,190,225 7,004,725 5,893,225 5,174,325
12. Add back noncash expenses (depreciation expense) 2,143,500 3,673,500 2,623,500 1,873,500 1,339,500
13. Cash flow from operations 6,262,225 7,863,725 9,628,225 7,766,725 6,513,825
14. Net working capital 3,500,000 4,000,000 5,000,000 4,250,000 3,750,000
15. Investment in NWC - -500,000 -1,000,000 750,000 500,000
16. Net salvage value 1,950,000
17. Total projected cash flow 6,262,225 7,363,725 8,628,225 8,516,725 8,963,825

Total projected cash flow is the sum of Row 13, 15, and 16.

Year Est. Sales of Sales
1 70,000
2 80,000
3 100,000
4 85,000
5 75,000

MACRS depreciation rates are as follows: -

Year 1 2 3 4 5 6 7 8

Equipment 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%

http://wise.fau.edu/~ppeter/fin3403/tax/macrs.htm
Net working capital is equal to 20% of annual sale.

Investment in NWC is equal to the change in net working captial from the previous year.

17. Net salvage value

Equipment
Salvage value 3,000,000
Initial cost 15,000,000
Book value 3,346,500
Capital gains income -
Ordinary income 3,000,000
Taxes (35%) 1,050,000
Net salvage value 1,950,000

Net Present Value

Required rate of return = 12.00%

First, we need to find the present value for the total projected cash flow by using the above required rate of return.

Present value of projected cash inflow 5,591,541 5,870,362 6,141,571 5,412,379 5,086,074

Total present value of projected cash inflow = 28,101,927

NPV = Initial investment + present value of projected cash inflow
NPV = -15,200,750 + 28,101,927
NPV = 12,901,177

Internal Rate of Return

The internal rate of return is defined as that discount rate which equates the present value of a project's expected cash inflows to the present
value of the project's costs:

PV(Inflows) = PV(Investment costs),

or the rate which forces the NPV to equal zero.

IRR = 40.20%

Payback period

Payback period is defined as the expected number of years required to recover the original investment.

Period 0 1 2 3 4 5
Net cash flow -15,200,750 6,262,225 7,363,725 8,628,225 8,516,725 8,963,825
Cumulative NCF -15,200,750 -8,938,525 -1,574,800 7,053,425 15,570,150 24,533,975

Payback = Year before full recovery + Unrecovered cost at start of year
Cash flow during year

= 2 + 1,574,800/8,628,225 = 2.18 years

PI

Profitability index is the present value of the future cash flows divided by the initial investment.

PI = 28,101,927
15,200,750

1.85