Question

The CFO of a company asks the financial analyst for a recommendation on two possible investment opportunities. One involves an initial investment of $550,000 but will earn $35,000 each year over the next 10 years. The second opportunity requires an initial investment of $750,000 with a $55,000 return over each of the next 10 years. The interest rate on loans to fund investment projects like this is 7%.

What should the financial analyst tell the CFO?

Option one should be undertaken because the 7.2% expected return exceeds the cost of borrowing.

Only option one yields an expected rate of return that is equal to the interest rate.

Only option two yields an expected rate of return that exceeds the interest rate.

Option two should be undertaken because the 7.2% expected return is less than the cost of borrowing.

The CFO of a company asks the financial analyst for a recommendation on two possible investment opportunities. One involves an initial investment of $550,000 but will earn $35,000 each year over the next 10 years. The second opportunity requires an initial investment of $750,000 with a $55,000 return over each of the next 10 years. The interest rate on loans to fund investment projects like this is 7%.

What should the financial analyst tell the CFO?

a. Option one should be undertaken because the 7.2% expected return exceeds the cost of borrowing.

b. Only option one yields an expected rate of return that is equal to the interest rate.

c. Only option two yields an expected rate of return that exceeds the interest rate.

d. Option two should be undertaken because the 7.2% expected return is less than the cost of borrowing.

Answer 1

Ans. Based on all the information and data in a question, the financial analyst should tell the CFO that Option one should be undertaken because the 7.2% expected return exceeds the cost of borrowing. So the correct option is A.