Suppose a firm anticipates that a particular R&D expenditure of $20 million will result in a new product and thus create a one-time added profit of $22 million a year later. The firm will
A)not undertake the R&D expenditure if its interest-rate cost of borrowing is 8 percent.
B)undertake the R&D expenditure if its interest-rate cost of borrowing is 12 percent.
C)undertake the R&D expenditure if its interest-rate cost of borrowing is 20 percent.
D)undertake the R&D expenditure if its interest-rate cost of borrowing is 9 percent.

Question

Quizplus · Accepted Answer

The firm will undertake the R&D expenditure if the present value of the future profit ($22 million) is greater than the cost of the R&D ($20 million). At an interest rate of 9%, the present value of $22 million a year later is approximately $20.18 million, which is greater than the $20 million cost.

Suppose a Firm Anticipates That a Particular R&D Expenditure of $20