Rekka Resin Moulding Inc.'s earnings before tax (EBT) has declined between 3% and 7% in each of the past five quarters. The company is trying to finance the purchase of a $55,000 injection moulding machine. The Kelowna-Picton Credit Union has made the best offer at 8.5%, 2.5% over Prime. At the same time, Penticton Injection Inc. a company with steady earnings growth, has received financing for a similar project with the loan provided at .75% under Prime. Due to its declining earnings Rekka will be facing

Question

Quizplus · Accepted Answer

EA risk premium is the extra interest rate or financial return demanded by investors for taking a higher risk, compared to a risk-free asset. In this case, Rekka Resin Moulding Inc. is being charged 2.5% over Prime because of its declining earnings, which is a direct reflection of the risk premium. However, the total risk premium is actually 3.25% when you consider that Penticton Injection Inc., a company with steady earnings, received financing at 0.75% under Prime. The difference between the rates (2.5% over Prime for Rekka and 0.75% under Prime for Penticton) is 3.25%, which represents the additional risk premium Rekka is charged due to its financial situation.An opportunity cost represents the benefits an individual, investor, or business misses out on when choosing one alternative over another. Since Rekka is paying 3.25% more than what a company with steady earnings pays, this extra cost can be seen as the opportunity cost of its declining earnings. However, the question does not provide enough information to calculate a monetary value for the opportunity cost or to confirm an opportunity cost of 2.5%. Therefore, the correct interpretation of the opportunity cost in this context is not provided in terms of a specific monetary value or percentage that matches the given options, but understanding the concept is crucial. The option E is selected based on the understanding that Rekka faces an opportunity cost in terms of the higher interest rate it must pay due to its financial health, which is directly compared to the more favorable rate received by a company in a better financial position.