To evaluate the options, we will calculate the Average Rate of Return (ARR) for each.
Formula:
ARR (%) = (Average Annual Profit / Initial Investment) × 100
Where, Average Annual Profit = (Total Net Cash Flow - Initial Investment) / Lifespan of project (years)
Step 1: Calculate ARR for Option 1 (Product Development)
- Total Net Cash Flow = $800,000/year × 4 years = $3,200,000
- Total Profit = $3,200,000 (Total Cash Flow) - $2,500,000 (Investment) = 700,000
- Average Annual Profit = $700,000 / 4 years = $175,000
- ARR (Option 1) = (175,000/2,500,000) × 100 = 7%
Step 2: Calculate ARR for Option 2 (Market Development)
- Total Net Cash Flow = $1,200,000/year × 4 years = $4,800,000
- Total Profit = $4,800,000 (Total Cash Flow) - $4,000,000 (Investment) = 800,000
- Average Annual Profit = $800,000 / 4 years = $200,000
- ARR (Option 2) = (200,000/4,000,000) × 100 = 5%
Step 3: Recommendation
Based on the ARR calculation, Option 1 (Product Development) offers a higher financial return (7%) compared to Option 2 (Market Development) (5%).
However, a final decision requires further strategic consideration. While financially superior, Product Development does not address the external threat of a new competitor in the domestic market. Market Development (Option 2), despite its lower ARR and higher initial cost, would diversify the company's revenue streams and reduce its dependence on a single market. The choice depends on the company's risk appetite and strategic priorities: maximising short-term profitability versus long-term strategic positioning and risk reduction.