Assume a machine that has a useful life of only one year costs $2,000. Assume, also, that net of such operating costs as power, taxes, and so forth, the additional revenue from the output of this machine is expected to be $2,300. If the firm finds it can borrow funds at an interest rate of 10 percent, the firm should .A. not purchase the machine because the interest rate exceeds the expected rate of return. B. purchase the machine because the interest rate exceeds the expected rate of retum. C. not purchase the machine because the expected rate of return exceeds the interest rate. D. purchase the machine because the expected rate of return exceeds the interest rate.

purchase the machine because the expected rate of return exceeds the interest rate.

Explanation:

Given the cost of machine = $2000

If the firm borrows fund at an interest rate of 10% to buy the machine,

Interest paid on the cost of machine = 10% of $200

= 10/100 × $2000

= $200

Total amount that must be paid back for the machine by the firm = actual cost of machine + interest rate

= $2000 + $200

= $2,200

Since the additional revenue generated from the machine after all operating cost = $2,300

Profit accrued by the firm = Revenue - (actual cost of machine + interest)

Profit accrued by the firm = $2,300-$2200

Profit accrued by the firm on the machine = $100

Based on the profit margin, it can be concluded that the firm can purchase the machine because the expected rate of return exceeds the interest rate.

Note that the expected rate of return is $300 (i.e $2300 - $2000) and the interest rate of is $200 (i.e 10% of $2000)

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