Question

You have invested in a business that proudly reports that it is profitable. Your investment of $5,200 has produced a profit of $290. The managers think that if you leave your $5,200 invested with them, they should be able to generate $290 per year in profits for you in perpetuity. Evaluating other investment opportunities, you note that other long-term investments of similar risk offer an expected return of 7.5%. Should you remain invested in this firm?

Answer 1

It would be financially advisable to reallocate the $5,200 investment from the business yielding an approximate return of 5.58% to a different investment offering a 7.5% return, provided that the risk profiles are similar.

Step-by-step explanation:

The question at hand is whether to stay invested in a business that offers a perpetual annual profit of $290 on an investment of $5,200, when other investments of similar risk can potentially offer a 7.5% return. To decide, we can compare the implied return rate of the current investment with the alternative. The return rate (R) can be found using the formula R = Profit / Investment. For the current investment, that would be R = $290 / $5,200, which yields approximately 5.58%. Since this is lower than the alternative 7.5% return, financially speaking, it would be wise to consider reallocating your investment to take advantage of the higher return rate. However, this decision should also factor in other considerations such as the specific risk profiles of the investments, liquidity needs, and personal investment goals.