Question

Apple Inc. is considering discontinuing its Model A brand of computers for a newer model which will sell for the next three years. The cost of developing this new model is $2,000,000 (including new machinery) and the company estimates that machinery from this project will have a scrap value of $100,000 at the end of the three years. The company expects to sell 500,000 units in the first year with sales volume experiencing a 10% growth per annum. Each unit will sell for $3,000 and is expected to have a unit cost of $1,000. The company expects marketing costs for its new model computers to be $1,000,000 per year. By discontinuing its Model A brand, Apple Inc. will forgo annual sales of $10,000.

1.What is the Net Present Value of the Project if the firm has a cost of capital of 12%?

2. Should Apple Inc. pursue this project?

3. What will happen to Apple Inc.’s share price if it were to pursue this project?

Answer 1

Net Incremental Cash Flow of the Launching Newer Model and discontinuing Model ‘A’ can be calculated as below:

Year	1	2	3
Sales (in Units)	500000	550000	605000
Sale Price (each unit)	$3,000	$3,000	$3,000
Revenue	$1,500,000,000	$1,650,000,000	$1,815,000,000
Variable Cost (each unit)	$1,000	$1,000	$1,000
Total Variable Cost	$500,000,000	$550,000,000	$605,000,000
Marketing Cost	$1,000,000	$1,000,000	$1,000,000
Operating Cash Flow	$999,000,000	$1,099,000,000	$1,209,000,000
Less: Annual sales of discontinued model	($10,000)	($10,000)	($10,000)
Net Incremental cash Flow	$998,990,000	$1,098,990,000	$1,208,990,000

Hence Project will have below mentioned cash flows:

• Development Cost of new model at time 0 i.e. -$2,000,000 at time 0
• Cash Flow of $998,990,000 at time 1
• Cash flow of $1,098,990,000 at time 2
• Cash Flow of $1,208,990,000 at time 3
• Scrap Value of Machinery at time 3 i.e. $100,000

NPV at capital cost of 12%

= -2,000,000 + 998,990,000/(1+12%) + 1,098,990,000/(1+12%)^2 + 1,208,990,000/(1+12%)^3 + 100000/(1+12%)^3

= -2,000,000 + 891955357 + 876108099 + 860535202 + 71178

= $2,626,669,836

Since NPV of this project is positive, Apple Inc. should pursue the project

Since, this project is resulting in substantial improvement in sales value resultantly Net Profit and creating value for shareholders, Apple Inc.’s share price would rise.