Rudy and Karyn come across an investment opportunity that offers them a guaranteed return. The terms of the investment are as follows:
Holding Period: 1 year
Initial cost: $1,000
Guaranteed Sales amount: $1,800
The couple is excited by the opportunity but they don’t have enough liquidity to put the cash forward the investment. You propose a solution: borrow the $1,000 under their Credit Line 1 (credit terms for this line of credit are listed in Question 1) and put it towards the purchase of the investment. In one year, sell the investment for the guaranteed amount, collect the cash, and pay off the balance of the debt. Assume at this time that the investment amount is the only debt that the couple has taken on.
How can you justify your proposal? What would be the net return of your proposal? Ignore the effect of taxes. (Hint: consider how the rate of return on the investment compares to the cost of borrowing money under this specific credit line)
Interest rate is 20%