1. Suppose a firm expects that a $20 million expenditure on R&D in the current year will result in a new product that can be sold next year. Selling that product next year would increase the firm’s revenue next year by $30 million and its costs next year by $29 million. LO15.3

a. What is the expected rate of return on this R&D expenditure?

b. Suppose the firm can get a bank loan at 6 percent interest to finance its $20 million R&D project. Will the firm undertake the project?

c. Now suppose the interest-rate cost of borrowing, in effect, falls to 4 percent because the firm decides to use its own retained earnings to finance the R&D. Will this lower interest rate change the firm’s R&D decision?

d. Now suppose that the firm has savings of $20 million—

enough money to fund the R&D expenditure without borrowing. If the firm has the chance to invest this money either in the R&D project or in government bonds that pay 3.5 percent per year, which should it do?

e. What if the government bonds were paying 6.5 percent per year?