Question

•Shin-Etsu Chemical Co. said Tuesday it will invest Y20 billion to raise its production capacity for methyl cellulose, used as a coating agent for drugs and an additive in cement, at two plants worldwide.

•Assume $143 million is spent on its German plant to increase production from 27,000 tons a year to 40,000 by 2006. Revenues are $4,000/ton. Costs are $1,000 per ton and $5 million per year. Interest rate is 14%. What is the payback period?

Answer 1

With 40,000 tons,

Annual revenue (R) = 4,000 x 40,000 = 160,000,000 = 160 million

Annual cost (C) = 1,000 x 40,000 + 5,000,000 = 40,000,000 + 5,000,000 = 45,000,000 = 45 million

Annual net benefit (NB) = R - C = 160 - 45 = 115 million

Since interest rate is given, we have to compute discounted payback period (DPBP).

Discounted payback period (DPBP) is the time by when cumulative discounted cash flows becomes zero.

Year	NB ($ Million)	PV Factor @14%	Discounted NB ($ Million)	Cumulative Discounted NB ($ Million)
0	-143	1.0000	-143.00	-143.00
1	115	0.8772	100.88	-42.12
2	115	0.7695	88.49	46.37

DPBP lies between years 1 & 2.

DPBP = 1 + (Absolute value of cumulative discounted NB, year 1 / Discounted NB, year 2)

= 1 + (42.12 / 88.49)

= 1 + 0.48

= 1.48 years