Suppose your firm is considering an investment project that will generate an expected return of 15%. The project costs $200,000. Suppose further that your firm has $100,000 of retained earnings. If the market interest rate is 10%, your firm should

Question

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Since the expected return on the investment project is 15%, which is higher than the market interest rate of 10%, it is profitable for the firm to invest in the project. However, the firm does not have enough funds to finance the project entirely, so it should consider borrowing the remaining $100,000 at the market interest rate of 10%. This is the best option since it allows the firm to take advantage of the higher expected return on the project while minimizing the cost of capital by using retained earnings for a portion of the financing. Neither option A nor B makes sense since the market interest rate is 10%, which is higher than the loan rate in option A and equal to the loan rate in option B. Option C is not viable because it requires the firm to loan out retained earnings at the same rate as the expected return on the project, which does not make sense from a financial perspective.

Suppose Your Firm Is Considering an Investment Project That Will