A manufacturing firm with a cost of capital of 12% is currently operating at below capacity and can accept additional manufacturing work as a subcontractor for another company. By doing so, the firm will receive $250,000 immediately and in each of the next two years. However, the firm will also have to spend $5 million next year rather than in three years to develop new capacity in order to meet increasing consumer demand for its services.
Should the firm take on the subcontracting job or conserve its excess capacity?
How much additional (annual) income from subcontracting would the firm need to generate in order for it to prefer subcontracting?