Here is the project: Spend $200,000 to increase plant capacity for Product B. The new capacity will cause profits to increase by $200,000 per year in the first year. The sales forecast is estimated to be 80% accurate.
The other project is Upgrade the MIS system for the company. There is a 100% certainty I will have manpower savings of $50,000 per year. The cost of the system is $400,000 of which $300,000 must be paid immediately and the remaining balance is projected to be paid at the end of the installation one year from now.
Project 3: Spend $500,000 in research and development to re-engineer product A whose patent is going to expire in two years. This product contributes $125,000 of after-tax profit per year. If the R& D project is successful, you will create $100,000 of after-tax profit for ten more years. Probability of success of the project is 75%
Please note that the difficulty arises because you have not been given the interest rate. Under such circumstances we use the payback period. Also it is not mentioned how long will the additional plant capacity last. Also it is important to use the same method if we want to compare the project with the other two projects. For this we use the payback period method for evaluating the proposals.
So the first project requires you to spend $200,000 to increase the plant capacity for product B. The new capacity will cause the profits to increase by $200,000 per year in the first year! This ...
The 431 word solution explains and calculates the payback period for each of the projects. The solution also explains how to deal with no stated interest rate.