IPhone 5 Case Study

Catalogue
Catalogue................................................................................................................... 1 I.Executive Summary:.............................................................................................. 1 II.Background.......................................................................................................... 2 III.Payback Period ................................................................................................... 2 IV.Profitability Index PI!.......................................................................................... " V.Internal #ate of #eturn I##! ............................................................................... " VI.$et Pre%ent Value $PV!...................................................................................... & VII.Ca%'( )ccounting( and *inancial Break+Even Sale%............................................& VIII.Sen%itivity )naly%i% on $PV ...............................................................................&

I.

Executive Summary:

Upon examining the possible deployment of the iPhone 5, we recommend the immediate release of the iPhone 5. Through all of the analysis done, only positive results pointing towards going ahead with the project have been found. The resulting payback period will be 1.73 years, well within the lifetime of the project. The profitability index is positive, at 91.78%. f !pple releases the iPhone 5 early, the "" will be either 41.13% or -58.26%. #hen adjusted using the $ "" method, the project results in 18.70%, over the #!%%. The calculated &P' for the early release of the Phone 5 will be $235,876,786, which also recommends !pple pursue this project. The %ash (reak)*ven +ales for the early release of the Phone 5 will be 3,370,370 units. The !ccounting (reak)*ven +ales for the early release of the Phone 5 will range between 3,541,704 units. The ,inancial (reak)*ven +ales for the early release of the Phone 5 will be 3,859,798 units. (ased on this sensitivity analysis it is found that if the price of the iPhone 5 is reduced by more than 4.3%, or to $387.59, the &P' drops to be negative. !s well, if the number of units sold goes below 21.5 i!!ion units or by 13.7%, the &P' drops below -ero. (ased on these results, we recommend the release of the iPhone 5.

II.

Background

!pple nc. is a successful company in the highly competitive an rapidly changing consumer electronics industry. t has established a uni.ue reputation and a devoted customer base. The Phone /+ was just released instead of the anticipated Phone 5. The Phone 5 suffered a technical stalemate due to the /0 1T* antennas being too large. !pple nc. has just found a way to solve the technical issues and of the Phone 5 and it is possible to release the device earlier than anticipated. %orporate $anagement needs to evaluate an early introduction of their latest model cell phone2 Phone 5. nitial 3ata given used in the analysis includes2 4. #orldwide annual sales of $42.91 billion in its fiscal year ending +eptember 56, 5778 5. %orporate tax rate2 36% 9. nvestor:s re.uired rate of return on average2 9% /. +pent $45,000,000 to develop an error)free prototype for the new Phone 5 5. +pent $3,000,000 for a marketing study to determine the expected sales for Phone 5 6. 'ariable cost of Phone 52 $270 each ;. ,ixed cost2 $455 i!!ion per annum <. *stimated sales volume for next five years2 12,000,000, 6,000,000, 5,100,000, 1,000,000 and 800,000 8. !verage unit price for Phone 52 $405 47. nitial investment2 $257 i!!ion 44. *.uipment depreciated on a se"en-yea# $%C&S s'hedu!e. 'alue of the e.uipment in five years will be $26 i!!ion. 45. &et working capital for the Phone 5 for a given year will be 17% of previous year:s sales and will occur with the timing of the cash flows for the year 49. Phone/ will no longer be available from year 5745= Production of Phone /+ is expected to be terminated in t(o yea#s. 4/. Phone /+ +ales without Phone 5 for next two years2 1,760,000 and 1,200,000 units 45. !verage price of Phone /+ without Phone 52 $400 per unit 46. 'ariable cost of Phone /+2 $270 each 4;. ,ixed cost Phone /+2 $22.7 i!!ion per year>no sa!"a)e "a!ue !e*t? 4<. +ales with Phone 52 decreased 560,000 units per year 48. !verage price with Phone 52 $310 each !ll !nalysis was done using $icrosoft *xcel@ and is included as appendix !

III.

Payback Period

The Payback Period for the early release of the Phone 5 will be 1.73 yea#s. This result is calculated by first obtaining the projects net cash flows along a per year timeline. Project &et %ash flows are obtained by taking the !fter)Tax Project Aperating ncome subtracting the change in &et #orking %apital >&#%? adding back 3epreciation. f applicable for that year, the +alvage 'alue, the Tax on 0ains, and the "ecovery of &#% will also be taken into account. ,or this project there is also a cannibali-ation effect on the Phone /+ that must be taken into account, the !fter)Tax %annibali-ation is defined as the change in Phone /+ net income. #e subtracted this from the previous sum.

The next step is to solve for the payback period, defined as the number of years re.uired to recover the funds invested in a project from its operating cash flows B4C. The first cash flow is the initial investment D)55;,777,777, the second cash flow >year 4? was D )456,848,577, but our third cash flow >year 5? was positive D 559,59/,777. The third cash flow amount covered the full amount of the past negative cash flows so the payback period point will be in this timeframe. To determine this point we summed the initial investment and the first year and divided it by the third cash flow. This gave us the payback point in the second year where the cash flows will start turning positive, but since this amount is in the second year we have to add 4 to account for the previous year that had a negative cash flow. Though a 4.;9 year payback is not extremely .uick it is still before the halfway point of the project life and gives an early enough timeframe to use future profit as investment in other projects. #e should accept the project. The *.uation can be written as2 Payback E &umber of years prior to full recovery F Unrecovered cost at start of year %ash flow during full recovery year

This assumes that the cash flows come in uniformly during the full recovery year B4C.

IV.

Profitability Index (PI)

The Profitability ndex for the early release of the Phone 5 will be 91.78% This result is calculated by obtaining the &et Present 'alue >&P'? divided by the initial investment. P is used to determine the amount of value per unit of investment. f the index is positive it is profitable. The Phone 5 early release is almost a 5 for 4 investment. #e should accept the project. The *.uation can be written as2 P E &P'G nitial nvestment

V.

Internal Rate of Return (IRR)

The "" for the early release of the Phone 5 will be 41.13% or -58.26% This result is calculated by setting the &P' to -ero and solving for "". The "" is used as an estimate of a projects rate of return. f the "" is greater than #!%%, we should accept the project. f it is less than #!%%, we should reject it B4C. Aur #!%% is given at 8H, but there are multiple ""s. $ultiple "" is caused by non)normal cash flows where the signs of the cash flows changes more than once. Aur cash flows start and end with negative values, creating a non)normal cash flow. The &P' will be positive as long as #!%% is between )5<.56H and /4.49H. This statistic has no meaning anymore. The *.uation can be written as2

&P' E %,7 F

%,4

F %,5 >4F ""?4

FI F %,& E 7 5 >4F ""? >4F ""?&

12(222(222(222 11(&22(222(222 11(222(222(222 1&22(222(222 I##, 01.1"/ 1+ +22/ 2/ 22/ 02/ .2/ -2/

I##, +&-.2./

+-2/

+.2/

+02/

1+&22(222(222 1+1(222(222(222

,igure JJ2 $ultiple "" points n order to correct this point, we must look at the $ ""2 The $ "" for the early release of the Phone 5 will be 18.70% "" assumes that the cash flows from a project are reinvested at the "". This normally is untrue and this causes the "" to overstate the true return. The $ "" assumes that cash flows are reinvested at the cost of capital or other predetermined rate. This makes it a better indicator of the project:s actual profitability. There can never be a multiple $ "", and it still is used for comparison against the cost of capital to justify accepting or rejecting a project. The $ "" in this project was calculated with the assumption that cash flows would be reinvested at the cost of capital, 8H. The $ "", 4<.;H is greater than the #!%%, 8H so we should accept this project. The *.uation can be written as2 $ "" E > ),' of positive cash flows at reinvestment rate? K 4Gn)4 >P' of negative cash flows at finance rate?

L4

VI.

et Pre!ent Value ( PV)

The &P' for the early release of the Phone 5 will be $235,876,786 This result is calculated by finding the present value of future cash flows, discounted at the cost of capital. &P' is used to show how much a project will contribute to shareholder wealth. The higher the &P', the more value added. f value is added the stock price will rise B4C. Using a #!%% of 8H the &P' is positive. f the &P' exceeds -ero, we should accept the project. The *.uation can be written as2

&P' E %,7 F

%,4

F %,5 >4F"?4 >4F"?5

FI F %,& >4F"?&

E 7

VII. "a!#$ %ccounting$ and &inancial Break'Even Sale!

The %ash (reak)*ven +ales for the early release of the Phone 5 will be 3,370,370 units.

The !ccounting (reak)*ven +ales for the early release of the Phone 5 will be2 2012 + 3,636,889 2013 + 3,846,296 2014 + 3,694,000 2015 + 3,617,852 2016 + 3,541,704

%(* and ,(* will be the same throughout the project life, while !(* will change because the depreciation is different from one year to another The ,inancial (reak)*ven +ales for the early release of the Phone 5 will be 3,859,798 units

VIII. Sen!itivity %naly!i! on PV

+ensitivity analyses were conducted to determine the effect a change in price and a change in the number of units sold would have on the &P'. The results of the sensitivity analysis are seen in the figure below.

Deviation from Base 25% $% &25% 'an(e

NPV with Sales Price and Unit Sales at Different Deviation from Base Sales Price Unit Sales $ 1,581,8 8,!2" $ !!#,"25, 82 $ $ $ 2%5,8 !, 8! &1,11$,125,$5! 2,!"2,$$%,!85 $ $ $ 2%5,8 !, 8! &1"%,1 2,2$" 858,$" ,""2

,rom the above figure we found that a change in sales price has a much greater effect than a change in units sold. #e can therefore say that the &P' is more sensitive to changes in the sales price than to changes in the number of units sold. f the sales price is set 55H above the expected price, we find that the &P' increases to D4,5<4,<;<,658. $eanwhile if the sales price is reduced to less than 55H of the expected price the &P' would reduce to )D4,447,455,756. Mistorically the iPhone is sold at a price marked higher than its competitors. This value normally hovers at D/75. 0iven the previous success of the iPhone it is possible to set the new iPhone 5 at this same sales price. Mowever the slow market and with a large number of competitors the iPhone 5 might need to be launched with a lower sales price. (ased on this sensitivity analysis it is found that if the price of the iPhone 5 is reduced by more than /.9H, or to D9<;.58, the &P' drops to be negative. Therefore, if !pple finds that it must reduce the sales price to less than /.9H of its current value, introducing the iPhone 5 at this moment would have an adverse effect upon the company. f the small market research firm miscalculated the number of sales its effect on the &P' would not be as great as if the price was changed. (ased on our sensitivity analysis if number of units sold is reduced by

more than 49.;H of the expected number of units the &P' also becomes negative. Therefore, if the number of sales estimated stays within a 49.;H error of margin !pple can still gain a profit.