An incumbent firm is considering expanding its capacity. It can do so in two ways. It can...

Question:

An incumbent firm is considering expanding its capacity. It can do so in two ways. It can purchase fungible general purpose equipment and machinery that can be resold at close to its original value. Alternatively, it can invest in highly specialized machinery which, once it is put in place, has virtually no salvage value. Assuming that each choice results in the same production costs once installed, under what scenario is the incumbent likely to encounter a greater likelihood of entry? Explain.

Salvage value:

In financial accounting, this term is concerned with the resale value of an asset once its productive life gets over. Therefore, it is usually used as one of the components to calculate the depreciation rate.

Answer and Explanation:

Here, the best decision by the firm is to invest in high-tech machinery because by investing in this type of machine, it's very difficult for the new entrants and competitors to operate more efficiently than the incumbent firm whereas the incumbent firm can run its business over the long-run. Further, it will create a situation for new entrants and competitors to re-think their decisions regarding whether to invest before entering to compete in this market or not.


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