Question

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

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

Step-by-step solution

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:

$$\begin{gathered} \text{r =}\frac{\text{12}}{\text{100}} \\ \text{= 0.12} \\ \text{NPV = - 60 -}\frac{\text{93.4}}{\text{(1 + r)}}\text{-}\frac{\text{56.6}}{{\text{(1 + r)}}^{\text{2}}}\text{+}\frac{\text{40}}{{\text{(1 + r)}}^{\text{3}}}\text{+}\frac{\text{40}}{{\text{(1 + r)}}^{\text{4}}}\text{+}\frac{\text{40}}{{\text{(1 + r)}}^{\text{5}}}\text{+}.........\text{+}\frac{\text{40}}{{\text{(1 + r)}}^{\text{15}}} \\ \text{= - 60 -}\frac{\text{93.4}}{\text{(1 + 0.12)}}\text{-}\frac{\text{56.6}}{{\text{(1 + 0.12)}}^{\text{2}}}\text{+}\frac{\text{40}}{{\text{(1 + 0.12)}}^{\text{3}}}\text{+}\frac{\text{40}}{{\text{(1 + 0.12)}}^{\text{4}}}\text{+}\frac{\text{40}}{{\text{(1 + 0.12)}}^{\text{5}}}\text{+}.........\text{+}\frac{\text{40}}{{\text{(1 + 0.12)}}^{\text{15}}} \\ \text{= - 60 - 83.39 - 45.12 + 28.47 + 25.42 + 22.70 + 20.27 + 18.09 +} \\ \text{16.16 + 14.42 + 12.88 + 11.50 + 10.27 + 9.17 + 8.18 + 7.31} \\ \text{=\$ 16.33} \end{gathered}$$

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