Investment Decision Rules:
Accept all investments with Net Present Value greater than Zero.
Accept all investments with Rates of Return greater than their Opportunity Costs of Capital
@ time 39.00
An example:
You are considering an investment opportunity that costs $100,000 and promises to return 10%.
A comparable investment in the financial market returns 15%.
A bank offers to lend you $100,000 at 8% with no conditions.
Questions:
1. Do you invest $100,000 in the investment opportunity?
Answer: NO
2. What is the investment's cost of capital?
Answer: 15%.
Reasons:
You should invest the $100,000 in the financial market that returns 15%.
The financial market provides the investing return standards against which other investments are evaluated.
Financing by the bank loan at 8% was irrelevant to the investment decision.
The investment decision and the financing decision are separate and independent decisions.
After you have made the investment decision, thus:
You are considering an investment opportunity that costs $100,000 and promises to return 10%.
A comparable investment in the financial market returns 15%.
Then you make the financing decision, thus:
A bank offers to lend you $100,000 at 8% with no conditions.
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