Pretend you are in a business meeting with you team. Your group received a phone proposal to invest in a new business. The call informs you that it will take a $70,000 down payment and the investelemt will return $10,000 a year for the next 10 years. He tells you that you that the investment will return 14 percent. If current interest rates are 8 percent, what is the present value of this investment? How did the call get 14 percent?
The net present value of the investment is ($2,684.43). The investment is not a value adding proposition, by making the investment you would expect to lose $2,684.43. The 14% was obtained by dividing the return of $10,000 by the investment of $70,000. This is faulty analysis, since it ignores the the actual cash out of $70k and the 10 payments of $10k.
Apr 10th, 2015
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