Problem: CleveCo, a profitable widget-maker, has developed an innovative new process to make widgets more efficiently. Two years ago, the company spent $1.75M in R&D to design the new process. CleveCo is deciding now whether or not to invest $750,000 in new equipment to implement the process. The equipment has an effective life of five years. One additional (highly skilled) operator will need to be hired to run the new machinery, at an annual cost of $90,000. Each widget currently costs $50 to produce but the new process will reduce costs by 10%. Sales are estimated to be 10,000 units a month for the foreseeable future.
a) What is the payback period of the decision to invest in the new equipment (you may neglect the time value of money)? Would you make the investment? Why or why not?
b) What if you were making the decision two years ago (before embarking on the R&D), with accurate knowledge of the full costs and benefits? Would you invest? Why or why not?