Question

When a firm invests in a new opportunity, if the return on that investment is 5% while the discount rate (required return) is 10%, then the investment has a ______ NPV.

a) Positive
b) Negative

Answer 1

An investment with a return of 5% when the discount rate is 10% has a negative NPV, indicating it's not financially beneficial.

Step-by-step explanation:

When a firm invests in a new opportunity and the return on investment (ROI) is lower than the discount rate, which in this case is 5% versus a required return of 10%, then the investment would have a negative Net Present Value (NPV). The NPV is calculated by discounting the expected cash flows from the investment by the required rate of return (discount rate) and deducting the initial investment cost. If the ROI is below the discount rate, it indicates that the investment is not generating enough return to cover the cost of capital, and therefore, the NPV is negative, meaning it's not financially beneficial to undertake.