In an effort to ensure the safety of cell phone users the fe

In an effort to ensure the safety of cell phone users, the federal communications commission (FCC) requires cell phones to have a specific absorbed radiation (SAR) number of 1.6 watts per kilogram (W/kg) of tissue or less. A new cell phone company estimates that by advertising its favorable 1.2 SAR number, it will increase sales by $1.2 million 3 months from now when its phones go on sale. At n interest rate of 20% per year compounded quarterly what is the maximum amount the company can afford to spend now for advertising in order to break even?

Solution

Equivalent interest rate   ( 1+.2/4)^4 -1 = .2155

Monthly rate .2155/12 = .10775 =10.775%

NPV of 1.2m$ paid 3 months hence at this interest rate is

1.2m$/(1.10796)^3 = 1.2m$/1.055= 1.138 m$

Hence advertising of 1.138m$ spent now will break even with the inflow of 1.2m$ 3 mos hence.