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iPhone cost expected to decline 20 percent annually

While initial sales of Apple Inc's new iPhone are expected to be modest due to its high price, the overall cost of the device is likely to fall at a 20 percent annual rate over the next 10 years, according to financial services firm Needham and Co.

Analyst Charles Wolf, who on Monday raised his 12-month price target on shares of the Cupertino-based iPhone maker to $135 from $115, said the declining cost will coincide with falling component prices and a rise in wireless carrier subsidies.

"The decline in price should accelerate demand as the iPhone invades the sweet spot of the mobile phone market," he wrote in a report distributed to clients.

Based on a series of calculated assumptions, including those related to price declines and subsidy increases, Wolf compiled a 10-year iPhone revenue and earnings forecast. In his model, the analyst assumed that Cingular will subsidize the iPhone $100 initially with the subsidy increasing $5 annually to $150 by the final year in his forecast.

"This reduces the price of the iPhone with a two-year plan to $76 in the final year of our forecast, equivalent to about a 20 percent annual decline," he told clients. "Our underlying assumption is that as Apple enhances the iPhone’s features and services, owners will use the phone’s data services more intensively and pay higher data access fees as a result."

By 2016, Wolf sees iPhone sales reaching 134 million per year, or approximately 7 percent of what is then expected to be a 2 billion unit-per-year global market. "To place this percentage in perspective," he noted, "Nokia’s sold over 300 million mobile phones in 2006 for a market share higher than 30 percent while Motorola shipped 160 million phones."

In his report, the analyst also said he would "not be surprised to see iPhone bars spring up in the Apple Stores once the product is launched in June."

iPhone revenue earnings forecast

Source: Needham and Co.

Wolf added that his free cash flow valuation model converts his iPhone forecast into $24 of value per Apple share.  "Factoring in cannibalization of iPod sales translates into a net addition of $20," he wrote.