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Simple economics/business question

  1. Sep 13, 2010 #1
    1. The problem statement, all variables and given/known data

    You are employed by a business to evaluate a proposed 1-year investment project that will cost $10,000 today, but generate for your firm certain earnings of $15,000 at the end of the year. The investment is thought to be virtually risk-free, but others in your firm are concerned about a possible worsening of cash flow problems that the firm is already experiencing. The problem with cash flows is hitting the firm hard, and with the firm's bank currently charging 20 percent on one-year loans.

    Should the firm undertake the investment project? Justify your decision.


    2. The attempt at a solution

    I really have no idea! It looks like an NPV question, but I really have no idea..
     
  2. jcsd
  3. Sep 13, 2010 #2
    Another way to look at this question would be to ask yourself: Which would be a better use of $10,000. Collection a 20% return in interest, or $5,000 profit from investment
     
  4. Sep 13, 2010 #3
    Oh.. so the 20% interest can be seen as something you can gain if you don't undertake the transaction!

    That would make it an NPV calculation?
     
  5. Sep 13, 2010 #4
    Well kind of, but you don't need to use any fancy formulas to assess if it's a net gain since you just need your NPV to be positive.

    Just ask which is bigger. $15,000 or 120% of $10,000.
     
    Last edited: Sep 13, 2010
  6. Sep 13, 2010 #5
    yes, great point. Thanks!

    This is a question on my assignment, and it's worth "5 marks". It is very concerning that a 1-step question would be worth 5 marks? Hmm. Maybe i'll do it your way & the NPV formula way just to scrape marks incase they have some lame marking criteria. I'll also try to invent some assumptions that the question is vague on.. :s
     
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