Question

he concept of risk and return is subjective for different people, as well as for corporations. Read and assess the following financial decisions. Keeping everything else constant, are the following actions good financial decisions? Base your decisions on the understanding of risk and return, solely from a theoretical finance perspective. Juan is a small-business owner. He has some cash flow and wants to invest in a new project. Juan’s assistant provides an evaluation and estimates the nominal returns that Juan would earn if he invests in the project. Juan reads the evaluation and makes the decision based on the real terms after factoring in inflation.

Answer 1

Juan is a small-business owner. He has some cash flow and wants to invest in a new project. Juan’s assistant provides an evaluation and estimates the nominal returns that Juan would earn if he invests in the project. Juan reads the evaluation and makes the decision based on the real terms after factoring in inflation - Yes, this is a good financial decision.

Step-by-step explanation:

The annual percentage of profit earned on an investment, adjusted for inflation is known as the real rate of return.

The nominal interest rate is the interest rate before taking inflation into account

Inflation reduces the value of money. Thus, calculating a rate of return in real value rather than nominal value, especially during a period of high inflation, gives a clearer picture of an investment's success.

The real rate of return adjusts profit for the effects of inflation, thus, it is a more accurate measure of investment performance than nominal return.

Usually, nominal rates are higher than real rates of return except in times of zero inflation or deflation.

Juan actually considered inflation rate, and made his decision on investment based his on real rate of return , and not nominal rate of return. Thus, he made a good financial decision.