1. Zaggy Zargawhoop has an idea for a new business. In order to develop his idea
ID: 1106802 • Letter: 1
Question
1. Zaggy Zargawhoop has an idea for a new business. In order to develop his idea, he needs to invest $300 today. Zaggy's idea will pay off $330 next year for certain. For this problem, assume that inflation is zero. Suppose that Zaggy has no savings to fund his idea and has to borrow money from the bank. a. Suppose that the interest rate for borrowing and for lending is 9%. Should Zaggy borrow money from the bank to fund his idea? b. Suppose that the interest rate for borrowing and for lending is 16%. Should Zaggy borrow money from the bank to fund his idea? Now suppose that Zaggy has $300 in his bank account. C. Suppose that the interest rate for borrowing and for lending is 9%. Should Zaggy withdraw his savings to fund his idea? d. Suppose that the interestrate for borrowing and for lending is 16%. Should Zaggy withdraw his savings to fund his idea? e. Does the method of financing (whether through savings or debt) appear to affect the relationship between the interest rate and the decision to undertake investment? Explain.Explanation / Answer
I. Zaggy Zargawhoop’s initial investment = $300
His expected return in one year = $330
The rate of return = 10%
a. Zaggy can borrow money from the bank if the interest rate for borrowing and lending is 9%, because the interest rate is less than his expected rate of return in business. He can see some profits by the end of the year.
b. When the borrowing and lending rate is 16%, it is not advisable for Zaggy to borrow money from the bank as the bank’s interest rate is pretty much higher than the rate of return of his proposed business.
c. Since the proposed business would fetch him 10% interest rate, Zaggy can withdraw money from the savings bank to fund his idea as it would be profitable to start the business. The rate of return on his business is higher than bank’s rate of interest.
d. Zaggy should not withdraw money from his bank if the interest rate on his account is 16%. Because he would be a loser if he withdraws as the rate of return is pretty less than the interest rate on savings account.
e. The method of financing appear to affect the relationship between the interest rate and the decision to undertake decision because Zaggy has to think about the opportunity cost of doing business. If the opportunity is higher, he has to keep his savings, and invest if it is less, when it comes to investing on his idea.
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