Question
Two years ago you bought a mobile phone on a 3-year contract which cost you $0 up front and requires monthly payments of $54 at
Two years ago you bought a mobile phone on a 3-year contract which cost you $0 up front and requires monthly payments of $54 at the end of each month. Today your friend Dan tells you he just bought a similar phone from another company for $132 up front and payments of only $40 at the end of each month. Furthermore, on the new plan, he can continue to pay the same $132 every 3 years to get a new handset.
(a) If your friend stays on the new plan for ever, and continues to buy a new handset every 3 years, what is the NPV of his decision to sign up? Both you and Dan have a discount rate of 1.08% per month.
(b) You are wondering whether to break your contract and switch to the new provider to get the lower monthly rate. Your current provider has a break clause which means you have to pay a fee of $440 to terminate the contract today. Meanwhile the new phone company is so keen to attract new business they are offering financial incentives for customers from other providers. They are willing to pay you an amount today towards your costs of breaking your old contract if you sign up for 3 years. You would also have to bring your own handset initially (which the old company will unlock as part of the break fee) but then every 3 years you can pay the $132 to get a new handset. If you don't switch now, your contract expires in 1 year and you can take up the fresh offer at that date like Dan has today. How much would the incentive need to be for it to be worthwhile for you to break the old contract today? Assume used mobile phones have no salvage value.
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