A broker wants to sell a customer an investment costing $100 with an expected pa

Question

A broker wants to sell a customer an investment costing $100 with an expected payoff in one year of $106. The customer indicates that a 6% return is not very attractive. The broker responds by suggesting the custoer borrow $90 for one year at 4% interest to help pay for the investment.

A. What is the customer's expected return if she borrows the money?

B. Does borrowing the money make the investment ore attractive?

What does the Irrelevance Proposition say about whether borrowing the money makes the investment more attractive.

Above is the question ... Would it make sense to start by calculating what the annual rate of return is for each?

Explanation / Answer

Invests 100 from pocket Amount Return on Investment=(106-100)/100 6 Borrow 90 and Invests 10 from pocket Interest Paid on 90 @4* 3.6 Earning after interest=(6-3.6) 2.4 Return on Investment=(2.4/10)*100 24 a>Customers Expectation if he borrows money will be 24% b>Yes,borrowing the money make the investment ore attractive

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