Table 9.2 Refer to Table 9.2.If a firm purchases the machine by taking out a one-year loan, what happens to the firm's rate of return on the investment if the interest rate increases to 10 percent?
A)It increases to 1.5 percent
B)It increases to 0.15 percent
C)It decreases to 1.5 percent
D)It decreases to 1.7 percent
E)It decreases to 0.17 percent

Question

Table 9.2  Refer to Table 9.2.If a firm purchases the machine by taking out a one-year loan, what happens to the firm's rate of return on the investment if the interest rate increases to 10 percent?
A)It increases to 1.5 percent 
B)It increases to 0.15 percent 
C)It decreases to 1.5 percent 
D)It decreases to 1.7 percent 
E)It decreases to 0.17 percent

Quizplus · Accepted Answer

If the interest rate increases to 10 percent, the cost of borrowing will increase, thereby reducing the firm's rate of return. The new interest cost can be computed as follows:

New interest cost = 0.1 x $20,000 = $2,000

The new net income will be:

New net income = $4,000 - $2,000 = $2,000

The new rate of return on investment can be computed as:

New rate of return = ($2,000 ÷ $130,000) x 100% = 1.54%

Therefore, the rate of return will decrease from 1.7% to 1.54%, choice C is the correct answer.

Table 92 Refer to Table 9