Thanks to acquisition of a key patent, your company now has exclusive production

Question

Thanks to acquisition of a key patent, your company now has exclusive production rights for barkelgassers (BGs) in North America. Production facilities for 240,000 BGs per year will require a $25.8 million immediate capital expenditure. Production costs are estimated at $73 per BG. The BG marketing manager is confident that all 240,000 units can be sold for $108 per unit (in real terms) until the patent runs out five years hence. After that the marketing manager hasnt a clue about what the selling price will be. Assume the real cost of capital is 12%. 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.

  

What is the NPV of the BG project? (Do not round intermediate calculations. Enter your answer to the nearest whole dollar.)

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, 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.

Explanation / Answer

Cash flow = 240000*(108-73)

=$8400000

since the production begins in year one the cash for year 1 is 0

NPV:

Year Cash flow Present Value 0 -25800000 -25800000 1 0 0 2 8400000 6696428.57 3 8400000 5978954.08 4 8400000 5338351.86 5 8400000 4766385.59 NPV -3019879.90

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