John Is Able to Take Out a Loan for $1,000

question 3

Multiple Choice

John is able to take out a loan for $1,000 for one year at an annual interest rate of 10 percent.After calculating his rate of return to be $200,John:

• A)will make money on net,and should take out the loan.
• B)will make money on net,and should not take out the loan.
• C)will not make money on net,and should take out the loan.
• D)will not make money on net,and should not take out the loan.

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Definitions:

MM Model

Refers to the Modigliani-Miller theorem, a foundational concept in corporate finance that states that under certain market conditions, the value of a firm is unaffected by how it is financed.

Arbitrage

The simultaneous buying and selling of the same commodity or security in two different markets at different prices, thus pocketing a risk-free return.

Capital Structure

The mix of a company's long-term debt, specific short-term debt, common equity, and preferred equity, which is used to finance its overall operations and growth.

Common Share Equity

The amount of money that would be returned to shareholders if a company's assets were liquidated and all its debts repaid, representing ownership in a corporation.