Question

JB Inc. (hence, JBI) has the opportunity to supply smart phones to telecom companies. JBI spent $1 million to develop a prototype for the new smart phone. From previous experience, JBI expects the phone will remain on the market for 3 years after which it will be replaced by an upgraded model. The company spent an additional $500,000 for a marketing study to help estimate expected sales figures for the new phone. JBI can manufacture the new phones for $215 each in variable costs. Fixed costs for the manufacturing operation are estimated to run $6.0 million per year. The estimated sales volume (units) is 200,000, 150,000, and 100,000 per year for the next 3 years, respectively. The unit selling price of the new smart phone will be $520. The equipment that is necessary to manufacture the phones can be purchased for $50.0 million and will be depreciated straight-line over 3 years to a salvage value of $5.0 million. JBI would need to increase its working capital by $3 million initially but would recover it at the end of the third year when production of the phone would cease. The Copycat Company (CC) has offered to manufacture the phones for JBI for $400 each. Regardless if JBI manufactures the phones or purchases them from CC, the selling price will remain $520. JBI has a cost of capital of 12% and a tax rate of 35%. Question: What is the expected cash flow in year 1 if JBI manufactures the cell phones?

a) $38 million

b) $104 million

c) $41 million

d) $65 million

Answer 1

Particulars	Amount
Selling price	520.00
Less:
Variable costs	(215.00)
Contribution per unit	305.00
× units	200,000.00
Total contribution	61,000,000
Less:
Fixed costs	(6,000,000)
Depreciation	(15,000,000)
Profit before tax	40,000,000
Less: taxes	(14,000,000)
Profit after tax	26,000,000
Add: depreciation	15,000,000
Cash flow for year 1	41,000,000

Answer is $41 million

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