Typical phases in the development of a new technology prior to deployment include re- search and development
Question:
Typical phases in the development of a new technology prior to deployment include re- search and development (R&D) demonstration, and commercialisation. In the latter phase, a successful prototype is prepared for deployment via incremental improvement of its performance and cost effectiveness based on learning effects. Within this context, an R&D firm considering the development of an innovative IT product is commencing the development stage and anticipates that upon completion, it will be able to sell the new product at price P with expected value P = 25 million. How- ever, the firm is aware that the price will depend on the market price of similar products at the time of deployment. Through empirical research, the firm identifies that the final sales price P is correlated with the market return as 20(M)^2 , where M is the standard deviation of the market rate of return. Also, the cost C of the R&D project is subject to technological uncertainty that will be resolved after the initiation of the project. Current estimations imply that the cost will be either 20 million or 16 million with equal probability. Assuming a 9% risk-free rate (rf ) and a 33% expected return on the market (rM ) determine:
i The expected rate of return of the project.
ii The of the project.
iii What is the excess rate of return compared to that predicted by the CAPM?
Management Accounting Information for Decision-Making and Strategy Execution
ISBN: 978-0137024971
6th Edition
Authors: Anthony A. Atkinson, Robert S. Kaplan, Ella Mae Matsumura, S. Mark Young