Essay on Aluminum Industry in 1994
1) Is primary aluminum production an attractive industry? Why or why not?
Within the framework of the Structure-Conduct-Performance (SCP) model3, the primary aluminum production industry (“the industry”) in 1994 can be described as perfectly competitive. The industry is characterized by a large number of competing firms – the largest of which has only 4.1% of total industry capacity; homogeneous, commodity-type products and low-cost entry and exit into and out of the industry (assuming capital is available where returns are greater than cost of entry). Within the industry, market prices are established via a commodities exchange (the …show more content…
2b) What do you expect the price of aluminum to be in 5 years? We have established that the primary aluminum industry in 1994 was perfectly competitive. In perfect competition we can also predict the price of aluminum by using the 1998 projected demand of 21 million tons and plotting the demand curve on the supply curve. See Exhibit 4. With the projected demand of 21 million tons, projecting price without taking into consideration the additional supply of Hillside, the price of aluminum in 5 years would be about $1500.00 per ton.
3) Assuming that Alusaf desires a 15% annual pre-tax ROI, should they build the proposed Hillside smelter? Based on the information presented in the case, Alusaf should invest in the Hillside project. As noted in the case, typical investments in smelting capacity (specifically, construction of a new facility) span five years, from investment decision to first production. The decision to invest hinges largely on projections that aluminum prices will rise in the future and those increases in price will allow Alusaf to return at its hurdle rate of 15%. It is acknowledged that given current aluminum prices ($1,110/ton) Alusaf would be unable to achieve the target 15% return on investment. However, given the activity taking place in the industry (production cutbacks & idling) and some early indications of success (prices