Sally has to decide between the following two options:
1)Take out a student loan of $60,000 and study accounting full time for the next three years.The interest on the loan is 5% per year payable annually.The principle to be paid in full after ten years.
"2)Study part time and work part time to earn $20,000 per year for the following six years.
Once Sally graduates,she estimates that she will earn $35,000 for the first three years and $50,000 the next four years.
Sally's banker says the market interest for a ten-year horizon is 7%.
Required:
a.Calculate NPV of the ten-year cash flows of the two options.For simplification assume that all cash flows happen at year-end.
b.Based on the NPV which of the two options is better for Sally?
c.What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision?"

Question

Quizplus · Accepted Answer

The Answer is

b.Option 1 results in a higher NPV.Based on this criteria alone,Sally should select this option.
c.The primary benefit of leveraging is the higher envisaged return.Drawbacks to increased financial leveraging include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy.

Sally Has to Decide Between the Following Two Options