Question

4. 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 O 1000*X 500*X 0 (1) Calculate the project NPV at the time of launch date as a function of X. SY 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 o? (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

Answer 1)
	Year 0	Year 1	Year 2
CAPEX	3.6B
EBITDA		9000*X-1.8B	8000*0.5X-0.5B
depreciation		1.2B	1.2B
EBIT		9000*X-3B	8000*0.5X-1.7B
Net income		(9000*X-3B)0.75	(8000*0.5X-1.7B)*0.75
FCF		EBIT - Taxes + Depreciation & Amortization - Capex – Change in Working Capital,
		(9000*X-3B)0.75+1.2B-1000*X	(8000*0.5X-1.7B)*0.75+1.2B-500*X
FCF
NPV=	(-3.6B)+(9000*X-3B)0.75+1.2B-1000*X/1.25+(8000*0.5X-1.7B)*0.75+1.2B-500*X/(1.25*1.25)
Answer 2)
If X=1 mn and launched in year 0
	FCF	(9000*1-3*1000)0.75+1200-1000*1
		4700
	NPV	160
If X=0.2 mn and launched in year 0
	FCF	(9000*0.2-3*1000)0.75+1200-1000*0.2
		100
	NPV	-3520
		If X=1 mn	If X=0.2 mn
		0.6	0.4
	combined chances	96	-1408
Answer 3)
If X=0.9 mn and launched in year 1
	FCF	(8000*0.5*0.9-1700)*0.75+1200-500*0.9
		2175
	NPV	-1860
If X=0.2 mn and launched in year 1
	FCF	(8000*0.5*0.2-1700)*0.75+1200-500*0.2
		425
	NPV	-3260
So if they are thinking to launch than they should launch in year 0, year 1 will bring loss even if customer sentiments are high for the phone.