Question

Huawei has spent ¥1.5B in R&D and is ready to launch the first foldable cellphone Mate X. However, they are not sure about whether consumers will like their new phones. They can choose to launch the product at year 0 or year 1. The costs of production will be the same whether they enter the market in year 0 or year 1. The life of Mate X will be 2 years in either case. The relevant cash flow information is given below. Suppose the unit sales will be X and 0.5X in the first and second year. The equipment will be depreciated in 3 years with no salvage value. Suppose the cost of capital is 15% per year. Marginal tax rate for Huawei is 25% and Huawei has enough earnings to realize all tax savings in all the years. Launch year Year+1 Year+2 Year+3 Revenue 17000*X 15000*0.5X COGS 8000*X 7000*0.5x Overhead 1.8B 0.5B CAPEX 3.6B Depreciation 1.2B 1.2B 1.2B Required NWC 1000*x 500*X O (1) Calculate the project NPV at the time of launch date as a function of X. O Suppose if they launch the phone in year 0, there is a 60% chance that consumers like the product, and X will be 1 million units. There is a 40% chance that consumers are disappointed about the product, and X will be 0.2 million units. If they launch the phone in year one, they will know whether consumers like foldable phones or not, and they can choose to not launch if situation is unfavorable. If they launch the phone in year 1 and the consumers like foldable phones, X will be 0.9 million. If they launch in year 1 even though consumers do not like foldable phones, X will be 0.2 million. (2) What is the NPV if they launch in year 0? (3) What is the NPV at year 1 if they launch in year 1? Calculate the NPV for both scenarios. Should they launch the phone if it is revealed that consumers do not like foldable phones? (4) What is the option value of delaying the launch?

Answer 1

Date. M/T /W/T/F/S/SU o calculation of NPV at the time of launch, a Year 3. a b) c) adala year I owe year 2 Revenue M 17000 x 7500n COGS ME (8000x) (35000) Overhead cost (0:50) depreciat on VC1.2B) (1.2 B d) (1.2)B e Requined oode - 10001 - 00 5000 NWC in Int to be paid (1000x 0.15) (500X0:15) = (150x) (751) | 0 88507 - 31 (17000x -8000X - 1500) = 0.25 3 985 - 1:7B 1 -123 75002 – 35002 - 7521) 0.25 0.25 (4 L marginal tax rate .Net 6637-52-2:25B .5625X-1'2753 -0.90B

Present value MT/W IT /FCS lows year I 6637.5X-3.250 year. 5625x-1.275 B year 3 -0.908 descount Retete....... (1+0:15) OD 5771.74% - 1.966 a to 15 2 a 4253.312 - 0.966. -(1+0:15)31 -0.598. NPV at the time of launch of 10,025.05x-3.51B as factor of a. - 12 launch calculation at year 0 DELO of x = sales Lovin 1 0.6 0.4 1 Ides no con= million meland = 0.g million. - Carol ang = -0.61 / million) + 0.4( od million) d 0.6m + 0.08m = 0 68 million. N on elaun this a value in the previous equation arrived =

M/T/W/T/F/S/SU S Date. = 10.095.05X - 357 BCA = 10,025.05 0.68m) - 3:51B 6317.034 m - 205B 100 6,81700B - 3.518 -1., 3.3070 B H 1 NPV when they launch at wear o = 313070B. ( If customers like foldable phone 2 = 0.9m. ) donot like x = 0.2m If customers Nou NPV if customers like = 10,025.050- 3.513 = 10,025.05(0.9m) - 3:51B = 9:022512 - 3.5JB = 5:5725 B. NPV if customers donot like hi - 10,025.05 (0.2m) - 3.578 a d .0050 B-3.5JB = -1,5050 B.

M/T /W /T/F /S /SU Date............. Therefore, as the NPV is negative they shouldnot lauch the toldable phone whes the customers donot like it (4 the value for delaying lauch to year 1 = the like it = when customers taken from, 5.51258 from 3, 3070 from 5.5125B - 3.3070 B 2.2055B. point a point 3.

The cost of capital given in the question( i.e. 15%) is used to discount the cash flows to present value.