Question

Suppose a number of your friends have organized a company to develop and sell a new software product. They have asked you to loan them $8,000 to help get the company started, and they have promised to repay your $8,000 plus 10% interest in one year. Of the following, which amount may be described as the return on your investment?

A) $8,000
B) $800
C) $8,800
D) $7,200

Answer 1

The return on the $8,000 investment with 10% interest after one year is Option C) $8,800, which includes both the principal and the interest earned. The firm considering an investment should compare the 6% return to opportunity costs of other investments before making a decision.

Step-by-step explanation:

The amount that may be described as the return on investment in the scenario where you loan your friends $8,000 and they promise to repay you with 10% interest in one year is Option C) $8,800. This is because the return on investment includes both the initial amount and the interest earned. The interest is calculated as 10% of $8,000, which is $800, so when you add that to the initial $8,000, you get a total of $8,800 that will be returned to you at the end of the year.

Regarding the question about whether a firm should make an investment with a 6% rate of return if it currently has the cash, the cost of financial capital is an important consideration. Since the firm does not have to pay 8% interest on a loan, it will not incur those additional expenses. Therefore, the firm is comparing the 6% return on the planned investment against the opportunity cost of investing that cash elsewhere. If the firm does not have a better investment opportunity that exceeds a 6% return, then it should proceed with the current investment.