Scarcity of capital

Suppose your firm has limited capital to invest in new R&D. Two lines of innovation (referred to as projects) have been proposed by managers. Project 1 costs $100,000 upfront in costs, but generates $50,000 in additional profits at the end of each of the next 4 years. Project 2 costs $150,000 in upfront costs, generating and additional $75,000 in profits at the end of each of the next three years. Assume the discount rate is 8%.

If capital is scarce, which project should be prioritized and why? Explain your answer.

Sample Solution

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