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Module 2 - In an economy far far away, the manufacturing of skin health tonic...

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Finance

Module 2 - In an economy far far away, the manufacturing of skin health tonic industry is competitive. Manufacturing facilities in this industry have an average annual output of 100,000 gallons. On average, operating costs are $2 per gallon while 100,000 gallon capacity plant costs $500,000 to build, but with indefinite life (and no salvage value). The appropriate cost of capital is 20% per year. Assume there are no taxes involved as it is a promoted industry by the corresponding government.

Required: A. What is the equilibrium price of tonic per gallon? [5 marks]

B. 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 (NPV) of building a new plant with new technology? [5 marks]

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