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Suppose a firm expects that a $40 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 firms revenue next year by $60 million and its costs next year by $58 million.a. What is the expected rate of return on this R&D expenditure?b. Suppose the firm can get a bank loan at 4 percent interest to finance its $40 million R&D project. Will the firm undertake the project?c. Now suppose the interest-rate cost of borrowing, in effect, rises to 6 percent because the firm decides to use its own retained earnings to finance the R&D.Will the firm undertake the project?d. Now suppose that the firm has savings of $40 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 6.5 percent per year, which should it do? Invest in bonds or R&D.e. What if the government bonds were paying 3.5 percent per year? The firm should invest in (bonds/R&D)
a. The rate of return = (gain from investment-cost of investment)/cost of investment = 60-40/40= 0.5 Thus, rate= 50% b. Yes, the bank will undertake the project at 4% rate of interest. c. The firm will undertake the project at 6% rate also. d. The rate of return on the R&D is 50% whereas that…

m investing in bonds is only 6.5%, thus, the company should invest in R&D only. e. If the bonds were paying 3.5% , the firm should invest in R&D because its return is more than that from bonds.


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