The manufacture of herbal health tonic is a competitive industry. The manufactur
ID: 2707064 • Letter: T
Question
The manufacture of herbal health tonic is a competitive industry. The manufacturing facilities have an annual output of 100,000 gallons. Operating costs are $2 per gallon. A 100,000-gallon capacity plant costs $500,000 to build and has an indefinite life, with no salvage value. The cost of capital is 20% (assume no taxes). Your company has discovered a new process that lowers the operating cost per gallon to $1.50. Assuming that the competition will never catch up and the market demand is sufficiently high, what is the net present value of building a new plant with new technology?
zero +$500,000 +$250,000 +$50,000Explanation / Answer
Initial cost = 500,000
Net profit each year = (2-1.5)*100,000 = $50000
net present value = 50000/20% =250,000
+$250,000
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