A new business opportunity has a 70% chance of being worth $500,000 next year and a 30% chance of being worth $100,000. The appropriate expected rate of return is 10%.
-Refer to the information above. Assume that the new opportunity will be financed with a $150,000 bank loan. What is the maximum amount of his own money that an owner should be
Willing to invest in this business?
A)$195,455
B)$345,455
C)$215,000
D)$230,000

Question

Quizplus · Accepted Answer

The maximum amount the owner should be willing to invest can be calculated using the expected value of the business and subtracting the loan amount. The expected value (EV) of the business is calculated as follows: EV = (0.70 * $500,000) + (0.30 * $100,000) = $350,000 + $30,000 = $380,000. To find the present value (PV) of this expected value, we use the formula PV = EV / (1 + r), where r is the rate of return. So, PV = $380,000 / (1 + 0.10) = $380,000 / 1.10 = $345,455. Since the owner is taking a $150,000 loan, the maximum amount of his own money he should be willing to invest is $345,455 - $150,000 = $195,455.

A New Business Opportunity Has a 70% Chance of Being