Question 1. 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).
a. 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?
b. If your company has discovered a new process that lowers the operating cost per gallon to $1.00 and assuming that the competition will catch up in three years and the market demand is sufficiently high, what is the net present value of building a new plant with new technology, assuming a $500,000 salvage value in Year 3?
c. Assuming the parameters of (b), but that the competition will catch up in five years and the market demand is sufficiently high, what is the net present value of building a new plant with new technology, assuming a $500,000 salvage value in Year 5?