Industry demand for your product is P=15,000/q. Current industry output (q) is 5000 units. A plant which produces 1000 units per year costs $10,000, has a variable cost per unit of $2, lasts indefinitely, and can be scrapped for $6,000 at any time. You have designed a new generation of plant which will reduce variable costs to $1.50 per unit. This plant also costs $10,000 and produces 1000 units per year (in perpetuity). You estimate that it will take two years for your competitors to institute a similar technology. The cost of capital is 10% and there are no taxes.
a. What will industry price and quantity be after time two (i.e. after competitors implement the new technology)?
b. What is the NPV of this new plant?
c. If you could build alternative sized plants, how big do you think the plant should be?