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
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: Which of the following costs should JBI ignore in its effort to solve the cell phone problem?
a) $3 million for working capital (since the company will recover it at the end of year 3)
b) $1,000,000 prototype cost
c) $5 million salvage value
d) all of these costs should be included
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