Question

You are making an investment where you have an exclusive patent for production of Barkelgassers (BGs) for a period of six years.

The investment will cost $25 million and production/revenue will not commence until year 2. Your production costs are $65 per BG and the marketing manager believes you will be able to sell 200,000 units at $100 per unit until the patent runs out in year 6 (five years’ time).

After that the marketing manager is unsure what the price will be as competitors will come into the market.

The real cost of capital is 9%, you assume the technology will not change and capital and production costs will remain the same. There are no taxes and BG production facilities will last for 12 years and will have no salvage value.

What is the NPV of the project?

Hint: You need to work out what the price will be per Barkelgassers when the competitors come into the market when the patent runs in year 6.

Answer 1

Current selling price = $100 per unit

Production cost = $ 65 per unit

Let us assume the price per Barkelgassers when patent runs out in year 6 be $80

Number of units sold per year = 200,000

Contribution per unit upto Year 6 = $100 - $65 = $35

Contribution per unit after year 6 until Year 12 = $80 - $65 = $15

It is specifically given in the question that production/revenue will not commence until Year 2, hence no cash flows will be generated in Year 1 and Year 2.

Hence, NPV of the project is $2,112,072.