The A Chemical Company

The A Chemical Company makes a wide range of products. About $10$ percent of its sales and profits are generated by one product called Basic.

At the current price of $$200$ per ton, the total world market of Basic is $2$ million tons. Currently, A Chemical and a foreign competitor, Nisson Chemical, share the world market.

The following price and cost information applies:

Price per ton

$$200$

Variable costs

$150$

Incremental profit

$ $50$

Both firms use essentially the same production processes and have the same cost structures. Both firms sell $1$ million tons per year.

A major consulting firm has recently studied the market for A Chemical Company and has concluded that the product is in a mature phase of its life cycle and that the demand curve is not apt to shift to allow additional price increases.

A university professor has recently published a journal article that could lead to a new manufacturing process for Basic. The A Chemical Company has tested the new process, and the management is convinced that the variable costs could be reduced from $$150$ per ton to $$50$ per ton.

The minimum capacity for the new process is $3$ million tons per year, and the new process would cost $$600$ million.

The A Chemical Company has a large tax$-$loss carryover and is not likely to be paying income taxes in the foreseeable future.

The A Chemical Company and Nisson have been competing for a number of years, and, given similar cost structures, they have avoided any extreme forms of price competition. The $$50$ incremental profit per ton is deemed to be a fair return on the capital currently being employed.

The A Chemical Company has been borrowing long$-$term funds at a cost of $0\mathrm{.}14$ and has computed its weighted average cost of capital to be $0\mathrm{.}20.$ It knows that Nisson uses $0\mathrm{.}10.$ The A Chemical Company has been using $0\mathrm{.}20$ as a hurdle rate to evaluate efficiency$-$increasing investments in any mature activities with little chance of growth.

There is reason to think that there will be no new significant cost$-$saving developments in the future and that the demand for the product will stay constant at $2$ million tons per year if the price of $$200$ per ton is not changed. The physical life of the investment is extremely long. It is reasonable to assume that the equipment will have an infinite life.

Question:

What do you recommend that the A Chemical Company does?