Question

a firm must decide which of three alternatives to adopt to expand its capacity. the firm wishes a minimum 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. which alternative should be selected? use a challenger - defender rate of return analysis.

alt.	initial cost	annual profit	profit rate
b	$300,000	$66,000	22%
c	$500,000	$80,000	16%

Explanation:

Step1: Recall the decision - making rule for rate of return analysis

In rate - of - return analysis, we choose the alternative with the highest rate of return that meets or exceeds the minimum acceptable rate of return. Here, the firm wants a minimum annual profit of 20% of the initial cost.

Step2: Compare the profit rates of the alternatives

Alternative A has a profit rate of 30%, Alternative B has a profit rate of 22%, and Alternative C has a profit rate of 16%.

Answer:

A. Alternative A should be selected as it has the highest profit rate (30%) which is greater than the firm's minimum required rate of 20%.