Question

Building a new factory to produce 50- and 60-inch TV screens can cost $4 billion. But for more than ten years, manufacturers of these screens have continued to build new plants. By building so many plants, they have expanded productive capacity at a rate that has exceeded the demand for big-screen TVs. In fact, during one recent year, the supply of big-screen TVs was estimated to exceed demand by 12%, rising to 16% in the future. One state-of-the-art plant built by Sharp was estimated to be operating at only 50% of capacity. Experts say that the price of big-screen TVs will have to fall much further than they already have before demand may eventually catch up with productive capacity.

What implications does the excess capacity have for the cash payback and net present value calculations of these investments?

Answer 1

ANS= There will be an increase in Payback period and a decrease in Net present value (or negative NPV).

# Cash payback = Initial investment / cash inflow per period

- CASH PAYBACK gives investor the estimate of, in how many years he will recover his total amount of investment through the cash inflow from the project that he had undertake.   As per the question if demand is less than supply than the firm's cash inflow will decrease due to which it will increase the cash payback.

# Net present value = Present value of all cash inflow - Present value of cash outflow.

- Net Present Value is the difference between the PV of cash inflow and PV of cash outflow. It is most popular    approach that investor use to check his return from investment. A project with higher NPV is always favorable to investors. If firm operates at excess capacity then supply will increase further more than the demand due to which future cash inflow fall that will cause a decrease in the present value of cash inflow. Hence there will be decrease in Net   present value or even bring it to negative.