OPTIMAL PLANT INVESTMENT PLAN
DETERMINATION OF NPV
Last edit: Sept 13, 2005 (part price = 1.25; discount rate
GOAL: Apply NPV criteria to a
problem of choice.
GENERAL PROBLEM DESCRIPTION:
You are working as an analyst
for a major materials manufacturing firm that has decided to enter the
structural ceramics market. Your boss has requested your recommendation
for a plant investment strategy.
You must choose from one of two alternatives. Plan A is to build
one plant with a maximum capacity of 10 million
parts/ year. Plan B is to build a plant with a capacity of 5
million parts/ year now, and to add a duplicate
facility three years hence. Plan A requires a larger initial
investment, but provides better economies of scale than
Plan B. Plan B sacrifices some production economies, but also
delays part of the capital outlay. Details of the
project and instructions for your report are provided below.
The cost model for this
exercise is available on the website. Look under the Course Material,
Spreadsheets Models link
- Plan A: build a single
10 million parts/ year facility now (Year 0).
- Plan B: build a 5
million part /year facility now, and a duplicate at Year 3, when demand
- Plants are built
and paid for a year prior to production (e.g. build at Year 0, sell at
- Initial demand is
2 million parts/year and will increase at a rate of 1.5 million parts/year,
to a maximum of 10 million parts/ year.
- The parts sell for
- Examine 10 years
of sales and use a discount rate of 13 percent.
). Going to this site leads you to a portion of the entire
spreadsheet model, with the
unprotected elements (which you can change) in blue. The entire
model is the result of extensive careful work of the
MIT Materials Systems Lab and has been used extensively in practice.
For this exercise, you need only change
the plant capacity and number of parts produced.
By changing the appropriate variables
in the model,
- Calculate the capital
investment costs for each plan.
- Calculate the manufacturing
costs for each plan, at each possible level of demand
(for Plan B, assume that production is split evenly between plants).
- Calculate annual
cash flows: volume*(price-cost) - capital investment (if any).
- Calculate the NPV
of both strategies.
- How does the preferred
choice change if the analysis timeframe is extended to 20 years, or shortened
to 5 years, of sales?
- For 5, 10 and 20
year timeframes, plot the difference between NPV(A) and NPV(B) for discount
rates ranging from 0 to 25 percent.
- Provide a report
which includes a consolidated printout of your NPV calculations, a copy
of the plot described, and a brief (one page) summary with recommendation
and discussion of issues.