Question

An article on fortune.com estimated that the cost of materials in Apple's iPhone 7 with 32 gigabytes of memory was \(\$ 225\). Apple was selling the iPhone 7 for \(\$ 649\). Can we conclude from this information that Apple is making a profit of about \(\$ 424\) per iPhone? Briefly explain.

Short answer

No, we cannot conclude that Apple is making a profit of about $424 per iPhone simply from this information. This figure only represents the difference between the selling price and the cost of materials, and other factors including labor, marketing, and research costs have not been considered in this exercise.

Step-by-step solution

Determine the Relevant Costs

We know both the cost of materials which is $225 and the selling price which is $649.

Calculate the Profit

To calculate the profit per iPhone, subtract the cost of materials from the selling price. So, the estimated profit would be $649 - $225.

Interpret the Result

The result obtained in step 2 does not necessarily mean that Apple is making that amount of profit per iPhone. There might be other costs (like labor, marketing, research, etc.) not taken into account in this exercise. This calculation merely provides a rough estimate of the profit per iPhone, based on the given data.

Key concepts

Profit Calculation

Understanding profit calculation is crucial to assessing a business's financial health. When calculating profit, the basic formula involves subtracting total costs from total revenue. In the example of Apple's iPhone 7, the direct costs known are the cost of materials at $225 and the selling price of $649.

• Estimated profit = Selling price - Cost of materials.

When we apply the numbers, we estimate:

• Estimated profit = $649 - $225 = $424.

However, this simple calculation can be misleading if additional costs involved in selling the product are ignored. Therefore, it’s important to understand that the estimated profit here is not definitive as it doesn't include some other relevant expenses.

Cost of Goods Sold

The Cost of Goods Sold (COGS) represents the direct costs attributable to the production of a product. This normally includes material costs and labor costs directly tied to manufacturing.
When evaluating COGS for the iPhone 7:

• The cost of materials is $225.

This figure only covers the manufacturing materials. Real-world COGS would include additional direct costs which are critical to understanding Apple's true production costs.
The true COGS might encompass:

• Direct labor costs: Wages for workers directly involved in production.
• Overhead costs: Utilities, facility maintenance for production areas.

Understanding COGS fully is crucial, as it's that part of the cost that directly affects gross profit, which is the revenue left after deducting COGS from total sales.

Operating Expenses

Operating expenses are essential for a complete picture of company performance. These expenses are the costs required to run the day-to-day operations that are not directly connected to producing a product. For instance, Apple's operating expenses would include:

• Employee salaries not connected to production.
• Marketing and advertising expenses.
• Research and development costs.
• Office supplies and administration.

Operating expenses are deducted from gross profit to determine operating profit, which more accurately reflects the profitability of the company. In the case of the iPhone 7, estimating just the material cost does not account for these operating expenses, which means the $424 gross margin may drastically decrease when these expenses are considered in a full profit and loss analysis.