Chapter 11, Problem 10PS

Economic rents Thanks to acquisition of a key patent, your company now has exclusive production rights for barkelgassers (BGs) in North America. Production facilities for 200,000 BGs per year will require a $25 million immediate 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 that the marketing manager hasn’t a clue about what the selling price will be. What is the NPV of the BG project? Assume the real cost of capital is 9%. To keep things simple, also make the following assumptions:

• The technology for making BGs 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 BGs in year 6.
• If your company invests immediately, full production begins after 12 months, that is, in year 1.
• There are no taxes.
• BG production facilities last 12 years. They have no salvage value at the end of their useful life.