1. Consider the following two projects Project A: Costs $10,000 today. Increases
ID: 1244145 • Letter: 1
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1. Consider the following two projects Project A: Costs $10,000 today. Increases profit by $4000 next year and $7,200 the year after that Project B: Costs $6000 today. Increases profit in two years by $6678 A firm faces a rate to borrow money of 8% and has the option of investing money with almost no risk at 6%. a) If the firm has $20,000 on hand, with only these two project to choose from, will they invest in A, B, neither or both? Show the calculations that lead to your conclusions. Explain whether you answers would be different for either project if the firm had no money on hand to invest. (2 points) b) Set up (but do not solve) and equation that would find the rate of interest where the firm is indifferent between investing in project A, and not investing in project A. (1 point) c) Explain, based on your calculations in (a), why the rate of return on project A must be somewhere between 6% and 8% (1 point) d) Use the data in (a) to bound the rate of return for project B, then use an equation like the one in (b) to actually find the rate of return of project B. Verify that it is consistent with the bound you found. (2 points)Explanation / Answer
Profits from project A: 4000 + 7200 = 11200
Profit from project B: 6678
Percent of project A profit against investment: 1200 / 10000 = 12 %
Percent of project profit B profit against investment: 678 / 6000 = 11.3 %
The answer clearly suggest that it is more profitable to investment in project A than in project B due to the fact that the returns are greater than project B. The answer which one to choose depends on various circumstances and conditions such as how much risk does a project involves, such as the higher the profit a business gives, the more riskier it is, if so is the situation then the money does be either deposited into the lesser riskier one, or else both as the profit is quite similar and it reduces the risk of losing all the money. If the risk is similar then the money should be invested in project A only.
If there wasn't any money in hands of the firm to invest, then they could borrow the money to invest, and obtain some profits on that. For example if they borrow money to invest in project A then the total amount that they 10800 or 6480 for project B, which will leave them to earn a profit of 400 for project A or 198 for project B.
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