Only #9 A company is considering introducing a new product. After performing mar
ID: 1221481 • Letter: O
Question
Only #9
A company is considering introducing a new product. After performing market research, they have determined that the product will have five possible outcomes, and have developed probabilities and resulting revenues for each outcome, as follows: What would be the expected present worth of this investment over three years given an initial investment interest rate of 12% compounded annually? A company is evaluating two projects. Project A and Project B. in order to determine if it should take on one of them. Project A has a higher rate of return than Project B. What should the company do?Explanation / Answer
Q9. In order to determine which project to choose, company should compare the rate of return of each project with minimum rate of return or cost of capital of each project.
The project choosen should be one whose difference between expected rate of return and minimum rate of return or cost of capital is higher.
So, even though project A has higher rate of return than project B, company can choose project B if difference between expected rate of return on project B and minimum rate of return or cost of capital with respect to project B is higher than the difference between expected rate of return on project A and minimum rate of return or cost of capital with respect to project A otherwise company can choose project A.
Thus, it is not the comparison of expected rate of return on two alternatives that should guide the decision to choose one but the comparison of difference between expected rate of return of each project with minimum rate of return or cost of capital that should guide the decision making.
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