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 percent (assume no taxes).Your company has discovered a new process that lowers the operating cost per gallon to $1.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?

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by considering the cost savings from the new process over three years, discounted at the cost of capital. The savings per year is $100,000 (since $1 saving per gallon for 100,000 gallons). The NPV of these savings over three years at a 20% discount rate is approximately $210,648.

The Manufacture of Herbal Health Tonic Is a Competitive Industry