Question

Wilson Motors is looking at expanding its operations by adding a second manufacturing location. If successful, the company will make $450,000. If it fails, the company will lose $250,000. Wilson Motors is trying to decide if it should borrow the $250,000, given the current bank loan rate of 15%. Should Wilson Motors borrow the money if

a.    the probability of success is 90%?

b.    the probability of success is 80%?

c.    the probability of success is 70%?

Answer 1

Answer:

Wilson Motors borrow the money if the expected payout exceeds cost of loan

a. the probability of success is 90​%?

Expected payout = .90($450,000) + .10(-$250,000) = $380,000

Cost of borrowing = $250,000 (1+.15) = 2,87,500

Expected Profit = 92,500

Answer: Borrow the money

b. the probability of success is 80%?

Expected payout = .80($450,000) + .20(-$250,000) = $310,000

Cost of borrowing = $250,000 (1+.15) = 2,87,500

Expected loss = 22,500

Answer: Borrow the money

c. the probability of success is 70%?

Expected payout = .70($450,000) + .30(-$250,000) = $240,000

Cost of borrowing = $250,000 (1+.15) = 2,87,500

Expected loss = -47,500

Answer: Do not Borrow the money