Thanks to the acquisition of a key patent, your company now has exclusive production rights for producing a new product called BigGassers (BGs) in North America. Production facilities for 200,000 BGs per year will require a $25 million capital expenditure. Production costs are estimated at $65 per BG. The BG 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 the patent expires, other companies will enter the market and the price will go down. Assume that: The real cost of capital is 9% The technology to produce BGs will not change. Capital and production technology will stay the same in real terms. If your company invests immediately, full production begins after 12 months. 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 BGs in year 6 There are no taxes BG production facilities last 12 years. They have no salvage value at the end of the 12 years. (4a) What is the NPV of the BG project? Hint 1: To compute the NPV, use the following timeline of events: At t = 0, the investment of $25 million is made to construct the plant. At t = 1, the plant is built and production begins; the first year of revenue and expenses is recorded at t = 2 (i.e. in year 1 there are no inflows or outflows) At t = 6, the patent expires and competition may enter. Since it takes one year to achieve full production, competition is not a factor until t = 7. From year 7 onwards, full competition will exist and thus any new entrant into the market for BGs will earn the 9 percent cost of capital. Hint 2: Starting from t7, you need to compute a new price so that the NPV of new investments by competitors is equal to zero. (4b) Is the concept of the Net Present Value actually used in financial decision making? Please support your argument using literature and articles.

Thanks to the acquisition of a key patent, your company now has exclusive production rights for producing a new product called BigGassers (BGs) in North America. Production facilities for 200,000 BGs per year will require a $25 million capital expenditure. Production costs are estimated at $65 per BG. The BG 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 the patent expires, other companies will enter the market and the price will go down. Assume that: The real cost of capital is 9% The technology to produce BGs will not change. Capital and production technology will stay the same in real terms. If your company invests immediately, full production begins after 12 months. 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 BGs in year 6 There are no taxes BG production facilities last 12 years. They have no salvage value at the end of the 12 years. (4a) What is the NPV of the BG project? Hint 1: To compute the NPV, use the following timeline of events: At t = 0, the investment of $25 million is made to construct the plant. At t = 1, the plant is built and production begins; the first year of revenue and expenses is recorded at t = 2 (i.e. in year 1 there are no inflows or outflows) At t = 6, the patent expires and competition may enter. Since it takes one year to achieve full production, competition is not a factor until t = 7. From year 7 onwards, full competition will exist and thus any new entrant into the market for BGs will earn the 9 percent cost of capital. Hint 2: Starting from t7, you need to compute a new price so that the NPV of new investments by competitors is equal to zero. (4b) Is the concept of the Net Present Value actually used in financial decision making? Please support your argument using literature and articles.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The real cost of capital is 9%
The technology to produce BGs will not change. Capital and production technology will stay the same in real terms.
If your company invests immediately, full production begins after 12 months.
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 BGs in year 6
There are no taxes
BG production facilities last 12 years. They have no salvage value at the end of the 12 years.

(4a) What is the NPV of the BG project?

Hint 1: To compute the NPV, use the following timeline of events:

At t = 0, the investment of $25 million is made to construct the plant.
At t = 1, the plant is built and production begins; the first year of revenue and expenses is recorded at t = 2 (i.e. in year 1 there are no inflows or outflows)
At t = 6, the patent expires and competition may enter. Since it takes one year to achieve full production, competition is not a factor until t = 7.
From year 7 onwards, full competition will exist and thus any new entrant into the market for BGs will earn the 9 percent cost of capital.

Hint 2: Starting from t7, you need to compute a new price so that the NPV of new investments by competitors is equal to zero.

(4b) Is the concept of the Net Present Value actually used in financial decision making? Please support your argument using literature and articles.

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