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Chapter 15: Q10. (page 606)

Reexamine the capital investment decision in the disposable diaper industry (Example 15.4) from the point of view of an incumbent firm. If P&G or Kimberly-Clark were to expand capacity by building three new plants, they would not need to spend $60 million on R&D before start-up. How does this advantage affect the NPV calculations in Table 15.5 (page 591)?

Discount Rate

0.05

0.10

0.15

NPV

80.5

-16.9

-75.1

Is the investment profitable at a discount rate of 12 percent?

Short Answer

Expert verified

The advantage affects the NPV by increasing by $60 million. Yes, the investment is profitable.

Step by step solution

01

Explanation

If there is no cost of $60 million before the start-up, then the NPV in Table 15.5 increases by $60 million. Thus, the table be:

Discount Rate

0.05

0.10

0.15

NPV

140.5 (=80.5 + 60)

43.1 (= -16.9 + 60)

-15.1 (= -75.1 + 60)

The NPV of the investment at 12% is calculated below:

r =12100= 0.12NPV = - 60 -93.4(1 + r)-56.6(1 + r)2+40(1 + r)3+40(1 + r)4+40(1 + r)5+.........+40(1 + r)15= - 60 -93.4(1 + 0.12)-56.6(1 + 0.12)2+40(1 + 0.12)3+40(1 + 0.12)4+40(1 + 0.12)5+.........+40(1 + 0.12)15= - 60 - 83.39 - 45.12 + 28.47 + 25.42 + 22.70 + 20.27 + 18.09 +16.16 + 14.42 + 12.88 + 11.50 + 10.27 + 9.17 + 8.18 + 7.31=$ 16.33

The positive net present value says that the investment will be profitable.

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