In 2010 the Cameron Manufacturing Company began working on a new version of its tried-and-true wind-powered water pump. For 15 years the firm had manufactured replacement parts for older-style windmills used on farms and ranches throughout the U.S. Southwest. However, the old-style pumps required the use of rods and leather seals that would wear out over time and require servicing. When Cameron's owners initiated the design of a new pumping process in 2013, they explored a number of possible designs and spent over $150,000 in fabrication and testing the new design before perfecting the system that they are now ready to place into production and begin marketing. To manufacture the new pumps Cameron will have to spend $750,000 on new equipment plus $300,000 in advertising and promotion for the launch of the new product. These expenditures will take place during 2013.
a. What is the relevant initial cost of the new pump product investment?
b. Cameron's management expects to sell 1,500 of the new units per year for the next 15 years and these units will produce free cash flow for Cameron of $150,000 per year. Furthermore, the firm's management estimates that the equipment purchased initially will last for the full 15 years, at which time it will have no salvage value. If Cameron uses a 10 percent rate of return to evaluate its investments, what is the NPV of the new pump investment?
c. Just as Cameron's management was about to launch the new investment, the firm's owner got a call from the A1 Windmill Company from Cross-Plains, Nebraska, inquiring about the possible purchase of the product design patent. The caller suggested that his company would be interested in paying as much as $110,000 for the exclusive rights to the new technology. Cameron would have to sign over all of its rights to the new design in return for the payment. How should this offer influence Cameron's decision to initiate manufacturing the new windmill design?