Assume Joe invests a total of $10,000 in a company-$5,000 of which is his own money and $5,000 of which he borrowed at a 10 percent interest rate.If the company's stock value decreases by 5 percent in one year at which time Joe sells his shares of the stock, what is Joe's rate of return on his investment?

Question

Quizplus · Accepted Answer

Since Joe borrowed $5,000 at a 10% interest rate, he will owe $5,500 at the end of the year ($5,000 principal + $500 interest). If the stock value decreases by 5%, Joe's investment is now worth $9,500 ($10,000 - 5%). Therefore, Joe's total return on his investment is -$1,000 ($9,500 - $10,500), or a rate of return of -10% (-$1,000 ÷ $10,000). However, since $5,000 of the initial investment was borrowed at a 10% interest rate, Joe will also owe the $500 in interest, resulting in a net rate of return of -20% (-$1,000 - $500 ÷ $10,000). Therefore, the best choice is C.

Assume Joe Invests a Total of $10,000 in a Company-$5,000