Question

Robert and John are both looking to invest in the same project. The investment is $800,000. Robert plans to make 20% down payment and take a loan for $640,000000 (The cost of the loan is 6% annually). John invest $800,000 in cash in the project, he doesn’t take any loan.

At the end of the project, a year later the project is sold for $960,000.

1. What will be the profit for Robert and for John?
2. What will be the return on capital for Robert and for John?                                                                                                                                                .

Now, the project loses 20%.

3. What will be the loses for Robert and for John?
4. What be the negative return on Capital for Robert and for John?

Answer 1

Solution:

Initial investment = $800,000

For Robert :

160,000 is down payment and 640,000 as loan at 6%

Interest amount = 640,000 * 6% =  38400

Project is sold for $960,000

Profit = $960,000 - Interest - 800,000 = $960,000 - 38400 - 800,000 = 121600

For John :

There is no interest component hence

Profit = $960,000 - 800,000 = 160,000

Part B

When the project loses 20% then the value of the project after 1 year = 960000*(1-0.2) = 768000

For Robert :

160,000 is down payment and 640,000 as loan at 6%

Interest amount = 640,000 * 6% =  38400

Project is sold for $768000

Profit = 768000 - 38400 - 800,000 = -70400

For John :

There is no interest component hence

Profit = 768000 - 800,000 = -32000

Return on capital

For Robert:

Return on capital = Profit / capital = -70400/800000 = -8.8%

For John:

Return on capital = Profit / capital = -32000/800000 = -4%