Question

A manufacturer wishes to make and sell 1.1 million units per year of an aviation part for 12 years with interest fixed at 14% per year. Option A is to build a manufacturing plant in the United States at a cost of $7 million, with endof-year expenses of $2 million per year. In order to meet environmental regulations, the manufacturer will need to invest $0.5 million for pollution control at the end of the fifth year. Option B is to build a manufacturing plant in Mexico for $4 million, with annual end-of-year expenses of $1.2 million. There will be a duty charge of 30% of the selling price in the United States. Find the aviation part selling price in the United States, at which the two options are equal.

Answer 1

Time = 12 years

Annual Unit Sales = 1.1 million

Discounting Rate = 14% per year

Let selling price of aviation part = $x

Annual Revenue = $1.1x million

Option A

Initial Investment = $7 million

Annual Expense per year = $2 million

Pollution Control Investment at t=5 year = $0.5 million

Option B

Initial Investment = $4 million

Annual Expense per year = $1.2 million

Duty Charge = 30%*Selling price in United States *Unit sales

Annual Revenue = $1.1x million

Option A

Option B

The NPV of both have to be Equal

So,

X = $23.59

So, the selling price of part is $ 23.60