Question

A mechanic is considering expanding his garage. After a strong year last year, the mechanic is able to finance the expansion from last year’s profits. The expansion itself is expected to cost $11,000. The mechanic estimates that the additional garage will bring in revenue totaling $12,000. The mechanic is currently receiving an interest rate of 8% on his saved profits. Should he make the investment?

Answer 1

No, the mechanic should not make the investment.

Step-by-step explanation:

Opportunity cost of expansion = 8% * $11,000 = $880

Total cost of expansion = Expected cost + Opportunity cost = $11,000 + $880 = $11,880

Net expected profit from expansion = Expected revenue - Total cost of expansion = $12,000 - $11,880 = $120

Rate of return from expansion = $120 / $11,880 = 0.0101, or 1.01%

Interest rate on saving = 8%

Since the rate of return from expansion of 1.01% is less than the 8% interest rate on saving, the mechanic should not make the investment.