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Question 2 The R.M. Company uses the following risk-adjusted discount rates for capital budgeting purposes: Investments in new product lines 14% Substitution of labour
Question 2 The R.M. Company uses the following risk-adjusted discount rates for capital budgeting purposes: Investments in new product lines 14% Substitution of labour with capital (machinery) 12% Expansion of existing product lines Replacement of existing equipment 10% 6% The firm has $500,000 of available capital for investment. Project A involves the production of a brand new product line. Project B involves the replacement of existing machinery. Project C involves the purchase of a more sophisticated piece of equipment as a replacement for existing machinery. This more sophisticated machine will enable R.M. Company to reduce the size of its workforce. There are no other projects available at this time. Expected cash flows for these independent projects are as follows: Projects A B C (in thousands of dollars) Year 0 (400) (500) (100) Net after-tax cash flows Year 1 160 130 30 Year 2 150 150 40 Year 3 140 180 50 Year 4 130 210 60 Which project(s) would you recommend the company undertake? Show your calculations and provide any necessary explanations. (4 marks) 1
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