A firm must decide which of 3 alternative to adopt to expand its capacity. The f

Question

A firm must decide which of 3 alternative to adopt to expand its capacity. The firm wishes the minimum annual profit of 20% of the initial cost of each separable increment of investment. Which ulternative should be selected use challenger-defender rate of return analysis Hint: compare investment over Do Nothing, increment B over A and increment C Alt. A Initial cost. Annual profit. Profit rate A. 100k. 30k. 30% B. 300k. 60K. 22% C. 500k. 80k. 16% A firm must decide which of 3 alternative to adopt to expand its capacity. The firm wishes the minimum annual profit of 20% of the initial cost of each separable increment of investment. Which ulternative should be selected use challenger-defender rate of return analysis Hint: compare investment over Do Nothing, increment B over A and increment C Alt. A Initial cost. Annual profit. Profit rate A. 100k. 30k. 30% B. 300k. 60K. 22% C. 500k. 80k. 16% Hint: compare investment over Do Nothing, increment B over A and increment C Alt. A Initial cost. Annual profit. Profit rate A. 100k. 30k. 30% B. 300k. 60K. 22% C. 500k. 80k. 16%

Explanation / Answer

Solution: Select Alternative A

Working:

Alt Initial cost Annual profit Chane in cost Change in profit change in profit rate Profit rate

A 100,000 30,000 30%

B 300,000 60,000 200000 30000 15 22%

C 500,000 80,000 16%

Because the firm requires a 20% profit on each increment of investment, one should examine the B- A increment of $200,000. (With only a 16% profit rate, C will be unacceptable.)

Alternative A gives a 30% profit rate. The $200,000 increment of investment of B insteadthan A, that is, B- A, has an 15% profit rate and will not be acceptable. Looked at this way, Alternative B has an overall 22% profit rate and be be considered as made up of Alternative A plus the B- A increment. Now because the B-A increment is not acceptable, Alternative B will not be adopted. Thus accept A

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