IPhone 5 Case Study
Catalogue
I.
Executive Summary: ......................................................................................................................... 1
II.
Background ....................................................................................................................................... 2
III.
Payback Period.............................................................................................................................. 2
IV.
Profitability Index (PI) .................................................................................................................. 3
V.
Internal Rate of Return (IRR) ........................................................................................................... 3
VI.
Net Present Value (NPV) .............................................................................................................. 4
VII.
Cash, Accounting, and Financial Break-Even Sales ..................................................................... 5
VIII.
Sensitivity Analysis on NPV......................................................................................................... 5
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%. If Apple releases the iPhone 5 early, the IRR will be either 41.13% or 58.26%. When adjusted using the MIRR method, the project results in 18.70%, over the WACC. The
calculated NPV for the early release of the IPhone 5 will be $235,876,786, which also recommends Apple
pursue this project.
The Cash Break-Even Sales for the early release of the IPhone 5 will be 3,370,370 units. The Accounting
Break-Even Sales for the early release of the IPhone 5 will range between 3,541,704 units. The Financial
Break-Even Sales for the early release of the IPhone 5 will be 3,859,798 units.
Based 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 NPV drops to be negative. As well, if the number of units sold goes below 21.5
million units or by 13.7%, the NPV drops below zero.
Based on these results, we recommend the release of the iPhone 5.
II. Background
Apple Inc. is a successful company in the highly competitive an rapidly changing consumer electronics
industry. It has established a unique reputation and a devoted customer base. The IPhone 4S was just
released instead of the anticipated IPhone 5. The IPhone 5 suffered a technical stalemate due to the 4G
LTE antennas being too large. Apple Inc. has just found a way to solve the technical issues and of the
IPhone 5 and it is possible to release the device earlier than anticipated. Corporate Management needs to
evaluate an early introduction of their latest model cell phone: IPhone 5.
Initial Data given used in the analysis includes:
1. Worldwide annual sales of $42.91 billion in its fiscal year ending September 26, 2009
2. Corporate tax rate: 36%
3. Investor’s required rate of return on average: 9%
4. Spent $45,000,000 to develop an error-free prototype for the new IPhone 5
5. Spent $3,000,000 for a marketing study to determine the expected sales for IPhone 5
6. Variable cost of IPhone 5: $270 each
7. Fixed cost: $455 million per annum
8. Estimated sales volume for next five years: 12,000,000, 6,000,000, 5,100,000, 1,000,000 and 800,000
9. Average unit price for IPhone 5: $405
10. Initial investment: $257 million
11. Equipment depreciated on a seven-year MACRS schedule. Value of the equipment in five years will
be $26 million.
12. Net working capital for the IPhone 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
13. IPhone4 will no longer be available from year 2012; Production of IPhone 4S is expected to be
terminated in two years.
14. IPhone 4S Sales without IPhone 5 for next two years: 1,760,000 and 1,200,000 units
15. Average price of IPhone 4S without IPhone 5: $400 per unit
16. Variable cost of IPhone 4S: $270 each
17. Fixed cost IPhone 4S: $22.7 million per year(no salvage value left)
18. Sales with IPhone 5: decreased 560,000 units per year
19. Average price with IPhone 5: $310 each
All Analysis was done using Microsoft Excel© and is included as appendix A
III.
Payback Period
The Payback Period for the early release of the IPhone 5 will be 1.73 years.
This result is calculated by first obtaining the projects net cash flows along a per year timeline. Project
Net Cash flows are obtained by taking the After-Tax Project Operating Income subtracting the change in
Net Working Capital (NWC) adding back Depreciation. If applicable for that year, the Salvage Value, the
Tax on Gains, and the Recovery of NWC will also be taken into account. For this project there is also a
cannibalization effect on the IPhone 4S that must be taken into account, the After-Tax Cannibalization is
defined as the change in IPhone 4S net income. We subtracted this from the previous sum.
The next step is to solve for the payback period, defined as the number of years required to recover the
funds invested in a project from its operating cash flows [1]. The first cash flow is the initial investment
$-257,000,000, the second cash flow (year 1) was $ -126,919,200, but our third cash flow (year 2) was
positive $ 523,534,000. 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 1 to account for the previous year that had a negative cash flow.
Though a 1.73 year payback is not extremely quick 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. We should
accept the project.
The Equation can be written as:
Payback = Number of years prior to full recovery
+
Unrecovered cost at start of year
Cash flow during full recovery year
This assumes that the cash flows come in uniformly during the full recovery year [1].
IV.
Profitability Index (PI)
The Profitability Index for the early release of the IPhone 5 will be 91.78%
This result is calculated by obtaining the Net Present Value (NPV) divided by the initial investment. PI is
used to determine the amount of value per unit of investment. If the index is positive it is profitable. The
IPhone 5 early release is almost a 2 for 1 investment. We should accept the project.
The Equation can be written as:
PI = NPV/Initial Investment
V. Internal Rate of Return (IRR)
The IRR for the early release of the IPhone 5 will be 41.13% or -58.26%
This result is calculated by setting the NPV to zero and solving for IRR. The IRR is used as an estimate
of a projects rate of return. If the IRR is greater than WACC, we should accept the project. If it is less
than WACC, we should reject it [1]. Our WACC is given at 9%, but there are multiple IRRs. Multiple
IRR is caused by non-normal cash flows where the signs of the cash flows changes more than once. Our
cash flows start and end with negative values, creating a non-normal cash flow. The NPV will be positive
as long as WACC is between -58.26% and 41.13%. This statistic has no meaning anymore.
The Equation can be written as:
NPV = CF0 +
CF1
+
1
(1+IRR)
CF2
+… + CFN
2
(1+IRR)
(1+IRR)N
= 0
$2,000,000,000
$1,500,000,000
$1,000,000,000
$500,000,000
IRR=-58.26%
IRR=41.13%
$-
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
$-500,000,000
$-1,000,000,000
Figure XX: Multiple IRR points
In order to correct this point, we must look at the MIRR:
The MIRR for the early release of the IPhone 5 will be 18.70%
IRR assumes that the cash flows from a project are reinvested at the IRR. This normally is untrue and this
causes the IRR to overstate the true return. The MIRR 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 MIRR, and it still is used for comparison against the cost of capital to
justify accepting or rejecting a project.
The MIRR in this project was calculated with the assumption that cash flows would be reinvested at the
cost of capital, 9%. The MIRR, 18.7% is greater than the WACC, 9% so we should accept this project.
The Equation can be written as:
MIRR = ( -FV of positive cash flows at reinvestment rate) ^ 1/n-1
(PV of negative cash flows at finance rate)
VI.
Net Present Value (NPV)
The NPV for the early release of the IPhone 5 will be $235,876,786
–1
This result is calculated by finding the present value of future cash flows, discounted at the cost of capital.
NPV is used to show how much a project will contribute to shareholder wealth. The higher the NPV, the
more value added. If value is added the stock price will rise [1].
Using a WACC of 9% the NPV is positive. If the NPV exceeds zero, we should accept the project.
The Equation can be written as:
NPV = CF0 +
CF1
(1+R)1
+
CF2
(1+R)2
+… + CFN
(1+R)N
= 0
VII. Cash, Accounting, and Financial Break-Even Sales
The Cash Break-Even Sales for the early release of the IPhone 5 will be 3,370,370 units.
The Accounting Break-Even Sales for the early release of the IPhone 5 will be:
2012 = 3,636,889
2013 = 3,846,296
2014 = 3,694,000
2015 = 3,617,852
2016 = 3,541,704
CBE and FBE will be the same throughout the project life, while ABE will change because the
depreciation is different from one year to another
The Financial Break-Even Sales for the early release of the IPhone 5 will be 3,859,798 units
VIII. Sensitivity Analysis on NPV
Sensitivity analyses were conducted to determine the effect a change in price and a change in the number
of units sold would have on the NPV. The results of the sensitivity analysis are seen in the figure below.
Deviation
from Base
25%
0%
-25%
Range
NPV with Sales Price and Unit Sales at Different Deviation from Base
Sales Price
Unit Sales
$
1,581,878,629
$ 664,925,782
$
235,876,786
$
235,876,786
$
-1,110,125,056
$
-193,172,209
$
2,692,003,685
$
858,097,992
From the above figure we found that a change in sales price has a much greater effect than a change in
units sold. We can therefore say that the NPV is more sensitive to changes in the sales price than to
changes in the number of units sold. If the sales price is set 25% above the expected price, we find that
the NPV increases to $1,581,878,629. Meanwhile if the sales price is reduced to less than 25% of the
expected price the NPV would reduce to -$1,110,125,056.
Historically the iPhone is sold at a price marked higher than its competitors. This value normally hovers
at $405. Given the previous success of the iPhone it is possible to set the new iPhone 5 at this same sales
price. However the slow market and with a large number of competitors the iPhone 5 might need to be
launched with a lower sales price. Based 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 NPV drops to be negative. Therefore, if Apple
finds that it must reduce the sales price to less than 4.3% of its current value, introducing the iPhone 5 at
this moment would have an adverse effect upon the company.
If the small market research firm miscalculated the number of sales its effect on the NPV would not be as
great as if the price was changed. Based on our sensitivity analysis if number of units sold is reduced by
more than 13.7% of the expected number of units the NPV also becomes negative. Therefore, if the
number of sales estimated stays within a 13.7% error of margin Apple can still gain a profit.