Question

Peter has a business opportunity that requires him to invest $10,000 today to receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to
his home, repairs that will cost at least $15,000 if he delays them for a year. Should Peter make the investment? If so, which alternative (b-d) is best? (Note: It’s okay in this case to consider the
financing decision along with the investment decision.)
A) No, since the net present value (NPV) of the investment, should he take it, is less than the net
present value (NPV) of the home repairs if he delays them for one year.
B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the
business opportunity, which has an NPV > $0 will mean that he will still come out ahead
after paying off the loan.
C) Yes, since the net present value (NPV) of the investment is greater than zero he can invest the
$10,000 in the business opportunity, and then next year use this money plus the benefit from
this money to make the necessary home repairs.
D) Yes, since the net present value (NPV) of the investment, should he take it, is greater than the
NPV of the home repairs if he delays for one year.

Answer 1

Answer:

B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the

business opportunity, which has an NPV > $0 will mean that he will still come out ahead

Explanation:

We should analyze considering the opportunity cost which is the cost of the best rejected alternative:

busines opportunity return: 12,000 - 10,000 = 2,000

bank loan: 10,000 -  11,000 = -1,000

home repairs 15,000 - 10,000 = 5,000

not doing the home repair will mean 5,000 dollar extra in repair expense next year therefore the best  option is to repair the home.

The question now, if it takes the loan to finance the business or not:

As the business will yield 2,000 and the loan -1000 the net amount will be 1,000 Thus it should take the loan and make the business investment.