Question

A manufacturing company is thinking about building a new factory. The factory, if built, will yield

the company $300 million in 7 years, and it would cost $220 million today to build. The company will decide to build the factory if the interest rate is

a. no less than 4.53 percent.
b. no greater than 4.53 percent.
c. no less than 5.81 percent.
d. no greater than 5.81 percent.

Answer 1

B) no greater than 4.53 percent

Step-by-step explanation:

We need to calculate the present value of $300 million using both discount rates:

present value₁ = $300 / 1.0453⁷ = $220

present value₂ = $300 / 1.0581⁷ = $202

In order for a project to be accepted, its NPV ≥ 0, and only if we use the 4.53% discount rate will our project have a NPV of 0 (= $220 - $220).

So the company will decide to build the factory only if the interest rate (discount rate) is no greater than 4.53%.