Question
A manufacturing company needs to build a factory at cost $50 million in order to produce machines, which will be operational after one year. The
A manufacturing company needs to build a factory at cost $50 million in order to produce
machines, which will be operational after one year. The factory can produce 10,000
machines per year for ten years and sell them at price $1,000 per machine, but in order to
do so must purchase widgets from a widget producing firm. It takes 1 widget to build 1
machine, and the cost per widget is $200. Prices do not change over time. In its last year of
production, the manufacturing company can sell the factory for $5,000,000. All expenses
and revenues of the company are riskless. The US Treasury yield curve is flat at 5%.
(a) Ellen is the manager of the manufacturing company, which she is considering financing
out of pocket. Should she finance the manufacturing company?
(b) Mark is the manager of the widget company, who must pay $10 million to build a
factory at date 0. His factory produces 10,000 widgets per year for 10 years (starting
in year one) at no additional unit cost, which are sold to Ellen at price $200. Assuming
no scrap value from the factory, should he finance the widget producing company?
(c) Ellen approaches Mark at date 0 and proposes to buy Mark's widget producing
company, after the widget factory has been built. If she buys it, she is then able
to build widgets herself without having to buy them. Does purchasing the widget
company from Mark boost the NPV of Ellen's company?
(d) Would your answer change if Ellen approached Mark before the widget factory was
built?
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