Question

John borrows $100,000 from the bank at 8% interest and uses the capital to start an internet marketing company. Based on his forecast of future profits over five years, he calculates his internal rate of return at 10%. Inflation is also running at 2%annually. Is this a good investment?

		Yes, John is earning a higher Internal Rate of Return that the loan.
		Yes, John's Internal Rate of Return with Inflation is returning 12%, and his loan is 8%.
		No, after inflation John is just breaking even and therefore not earning a profit.
		There's not enough information to answer this question.

Answer 1

Correct answer is :

No, after inflation john is just breaking even and therefore not earning a profit.

John has taken a loan on 8% interest rate.

The internal rate of return is 10% which is higher than the cost of borrowing of 8%. However, inflation of 2% is offsetting the benefit of higher rate of return of 10% making the net return to 8%(10%-2%) which is equal to the cost of borrowing of 8%.

Hence, john is just breaking in and not earning any profit. He is in a no profit no loss situation as cost of borrowing=internal rate of return=8%