Question

8-37 A firm must decide which of three alternatives to adopt to expand its capacity. The firm wishes a min- imum annual profit of 20% of the initial cost of each separable increment of investment. Any money not invested in capacity expansion can be invested elsewhere for an annual yield of 20% of initial cost. Alt. A B C Initial Cost Annual Profit $100,000 $30,000 300,000 66,000 500.000 80.000 Profit Rate 30% 22% 16% Which alternative should be selected? Use a challenger-defender rate of return analysis.

Answer 1

Answer: | tabටපට - I * Since the from scauires a 20% profit on each increment. E of investment, and the alternative cfailed to produce the 2016 minimum annual profit. * Now we should examine the B-A incöcment of $200,000. (with only a 16•n profit sate, cis ouacceptable?. hare the table, Art Intial cast | Annual cost scost aprofit opsoft 30000 660000 200000 36000 C T 500000 800000 * Alternative A produces a 30% profil sabe; The 200,000 I increment of investment of B rather than t, ie, *B-A has an 18% profit date and is not acceptable. looked I at this way. * Alternative B with an overall 22%. Profit rate may be Considered as made up of Alternative A plus the B.A. increment. 18%, 300000 * Thus, the best investment of $300,000 for example, would be. Alternativa A (Annual profit: $30,000) + 200,000 Cxiciding 204.100) $40,000 anually). * This Combination gields a $70,000 profit, which is better than Alternative B profit of $ 66,000, so selet a