Penelope’s Personal Pocket Phones

Penelope’s Personal Pocket Phones

Penelope Phillips is in the middle of a big decision, whether or not she should start a company focused on the next generation of wireless phone technology. She is an electrical engineer and holds 15 patents, and she wants to leverage these competencies in order to start her company. However, the market is very competitive and she knows it would not be easy. Penelope knows that if she enters the market today there might be bigger opportunities in the future, so she must take great care valuing the opportunities.  

        In order to determine if it is a good idea for Penelope to enter the market, we will need to do a discounted cash flow analysis to determine the NPV of the project. In theory, if the NPV is greater than zero, we would recommend that the project be undertaken. For our first attempt at determining if Penelope should enter the market we looked at the first-generation phone project alone. We used the pro forma projections given by Penelope in order to determine free cash flows from 2001 to 2006. We were then able to discount these cash flows to determine the NPV. In order to accurately value this project, we used a discount rate of 14.80%. Since the 10-year treasury was yielding 10%, we used that as the risk free rate. The industry beta was determined to be 1.2 and the market risk premium was 4%. Combine these factors into the equation and we came up with our 14.80% discount rate. After all the calculations, we determined an NPV of -$3.37mm. Therefore, if Penelope were to enter the market based solely on the potential outcome of the first generation phone, we would recommend that she does not enter the market. Calculations supporting this statement can be found in Exhibit 1. 

        In order to help Penelope identify the current expected value of the second-generation phone project we used the Black-Scholes Valuation Model. We were able to use this model along with solver in Excel to come up with the expected value of the second generation phone project. We set the call value in the Black-Scholes model to equal $3.37mm (since that would offset the -$3.37mm from the first-generation phone project. We determined the future cash flows needed to achieve this value for the second-generation phone project to be $25.42mm. Penelope can use this information to determine if taking the loss in the first-generation phone project is worth it. If the future cash flows are greater than $25.42mm, we would recommend that Penelope enter the market and take the loss on the first-generation phone project, so that she can realize the benefits of the second-generation phone project. Calculations supporting this statement can be found in Exhibit 2.