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 general category of problem JBI will have to solve relative to the possibility of getting into supplying smart phones to telecom companies?

a. Long-term planning and growth

b. Minimizing its taxes

c. Finding its WACC

d. Making a capital investment

Answer 1

The general category of problem that JBI will have to solve relative to the possibility of getting into supplying smart phones to telecom companies is the decision whether to make capital investment and produce the phones itself or to procure it directly from copycat company.

a. Long-term planning and growth - it will need to be done irrespective of own production or procure from outside

b. Minimizing its taxes - same as above

c. Finding its WACC - it is already given

d. Making a capital investment - correct answer