Payback period, profitability index, AIR, NP, and a sensitivity analysis will be calculated to figure out if this is a good investment opportunity for the company or f they should reject the project. Analysis 1 . What is the payback period of the project? The payback period is approximately 3 years for the new PDA design. “The payback investment rule, states that you should only accept a project If Its cash flows pay back Its Initial Investment within a specific period” (Beer, & Demeanor, 201 1, p. 164).
Firms usually use the payback rule first because It Is easiest and fastest to calculate but they usually also calculate the AIR and NP before making a decision to accept or reject a project (Beer, & Demeanor, 2. What is the profitability index of the project? The profitability index for 011). The new PDA is . 557 which is the value created in terms of NP per unit of resource consumed (Beer, & Demeanor, 2011). “Practitioners often use the profitability index to identify the optimal combination of projects to undertake in such situations” (Beer, & Demeanor, 2011, p. 172).
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It is especially helpful if a firm is trying to decide which project to take on out of several different projects, it helps to find the most profitable. 3. What is the AIR of the project? The AIR of the new PDA Is 28. 31% and since the cost of capital is 12% this Investment would be recommended to undertake. As Beer & Demeanor, 2011, describe applying the AIR rule “Take any Investment opportunity where the AIR exceeds the opportunity cost of capital” (p. 160). Just like the payback and the NP rules, AIR Is usually applied to stand alone projects such as the new PDA design that Conch Republic is considering. . What is the NP of the project? The NP of the new PDA is $18,096,793. 00 and since this is a positive number the NP rules states to accept the project. “Although the NP rule is the most accurate and reliable decision rule, in practice a wide variety of tools are applied often in tandem with the NP rule” (Beer, & Demeanor, 2011, p. 58). These other tools for example are the AIR, profitability index, figuring the payback period and conducting a sensitivity analysis. 5. How sensitive is the Invent changes in the price of the new PDA?
As illustrated in appendix A table 1, the NP is sensitive to changes in the price of the new PDA. “Sensitivity analysis breaks the NP calculation Into its component assumptions and shows how the NP varies as the underlying assumptions change” (Beer, & Demeanor, 2011, p. 201). The sensitively analysis performed was to show the difference In price with an Increase and decrease In price by 10%. . How sensitive is the NP to changes in the quantity sold? The sensitivity analysis by 10%.
The increase raised the NP to $12,959,41 5 and the decrease lowered the Novo 7. Should Conch Republic produce the new PDA? Yes, Conch Republic should produce the new PDA since the AIR is larger than the cost of capital and the NP is positive. The profitability isn’t a big factor since this is a stand-alone project. The sensitivity analysis also supports the decision to accept the project. 8. Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?
This is to be expected, the new model will cost more and Conch Republic should want customers to purchase the newer more expensive model instead of the older model. They should slow down on production of the older model and plan only producing it for warranty replacements or to have a few on hand as the less expensive alternative. This would not affect my analysis since as a company they should plan on selling the new model more than the older model to produce more revenue. Conclusion In conclusion this analysis evaluated the investment opportunity for Conch
Republic Electronics for designing a new PDA. This analysis was evaluated using payback period, profitability index, AIR, NP, and a sensitivity analysis. Any electronics company is going to have to upgrade their devices to stay relevant and to get customers to want to buy their products. If Conch Republic couldn’t afford to upgrade their PDA, this would be a bad sign for their company overall since it is imperative for a company to be innovative to be sustainable. Beer, J. , & Demeanor, P. (2011). Corporate finance: the core. (2nd deed. ). Boston, MA: Pearson Education.