Suppose that a firm can invest $100 today in a project and receive $105 a year from today. There is no inflation, and the annual interest rate in the economy is 4%. The firm should
A) invest in the project because the opportunity cost is less than the return on the investment.
B) invest in the project because the opportunity cost is greater than the return on the investment.
C) invest in the project because the opportunity cost is the same as the return on the investment.
D) not invest in the project because the opportunity cost is less than the return on the investment.

Question

Quizplus · Accepted Answer

The opportunity cost of investing is the return that could have been earned if the money had been invested elsewhere. At an annual interest rate of 4%, the opportunity cost of not investing the $100 is $104 after one year ($100 * 1.04 = $104). Since the return on the investment is greater than the opportunity cost, the firm should invest in the project.

Suppose That a Firm Can Invest $100 Today in a Project