Thanks to acquisition of a key patent, your company now has exclusive production rights for special internet-connected spectacles (ICS) in Europe. Production facilities for 200,000 ICSs per year will require a $25 million immediate capital expenditure. Production costs are estimated at $65 per ICS. The marketing manager is confident that all 200,000 units can be sold for $100 per unit (in real terms) until the patent runs out five years hence. After that the marketing manager can only guess what the selling price will be. Assume a real cost of capital is 9%. 1. What is the NPV of the ICS project? Make the following assumptions: The technology for making ICSs will not change. Capital and production costs will stay the same in real terms. Competitors know the technology and can enter as soon as the patent expires, that is, they can construct new plants in year 5 and start selling generic ICSs starting in year 6. If your company invests immediately, full production begins after 12 months, that is, in year 1. There are no taxes. ICS production facilities last 12 years. They have no salvage value at the end of their useful life. (Hint: beyond year 6 you can set a unit selling that yields a zero NPV.) 2. How would your answer change if technological improvements reduce the cost of new ICS production facilities by 3% per year? Thus a new plant built in year 1 would cost only 25 (1-.03) = $24.25 million, a plant built in year 2 would cost $23.52 million, and so on. Assume that production costs per unit remain at $65.
Thanks to acquisition of a key patent, your company now has exclusive production rights for special internet-connected spectacles (ICS) in Europe. Production facilities for 200,000 ICSs per year will require a $25 million immediate capital expenditure. Production costs are estimated at $65 per ICS. The marketing manager is confident that all 200,000 units can be sold for $100 per unit (in real terms) until the patent
runs out five years hence. After that the marketing manager can only guess what the selling price will be. Assume a real cost of capital is 9%.
1. What is the NPV of the ICS project? Make the following assumptions: The technology for making ICSs will not change. Capital and production costs will stay the same in real terms. Competitors know the technology and can enter as soon as the patent expires, that is, they can construct new plants in year 5 and start selling generic ICSs starting in year 6. If your company invests immediately, full production begins after 12 months, that is, in year 1. There are no taxes. ICS production facilities last 12 years. They have no salvage value at the end of their useful life. (Hint: beyond year 6 you can set a unit selling that yields a zero NPV.)
2. How would your answer change if technological improvements reduce the cost of new ICS production facilities by 3% per year? Thus a new plant built in year 1 would cost only 25 (1-.03) = $24.25 million, a plant built in year 2 would cost $23.52 million, and so on. Assume that production costs per unit remain at $65.
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