Question 9.2: The XYZ Company has $50 million which can be invested in pro......
The XYZ Company has $50 million which can be invested in proposal A (i^*_A = 17%) or in proposal B (i^*_B = 29%); or else it can exercise the do-nothing alternative and invest the $50 million in modernizing current operations. A target MARR of 35% has been established by XYZ’s management to achieve their long-range plans and strategies. The XYZ Company currently earns an average of 25% on its total investment in plant and equipment, some of which is very old. Which alternative should XYZ pursue?
For the do-nothing alternative, i* = 25%; thus, none of the three alternatives meets the desired 35% MARR. If the company is serious about the 35% MARR, then additional alternatives should be sought. Proposal B, which has an ROR slightly better than the current average rate of return on total investment, would clearly enhance the company’s average rate of return. In addition, given that some of the company’s plant and equipment is “very old,” using the available $50 million for refurbishing this old plant and equipment might also improve the company’s average rate of return. One reasonable strategy would be to spend part of the $50 million on new plant and equipment, and then to search for higher-profit proposals (e.g., a 35% ROR) on which to spend the balance.