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Should this Firm Build a Factory?

Question: Assume that a firm is considering building a factory that will cost $5 million. It believes that it can get a profit from this factory of $600,000 per year for many years. The interest rate at which the firm can borrow money is 15 percent. After evaluating whether it should build the factory, the firm decides that it should:

1. Build because the rate of return on the factory is 35 percent.
2. Not build because the rate of return on the factory is only 6 percent.
3. Build because the rate of return on the factory is 30 percent.
4. Not build because the rate of return on the factory is only 12 percent.

Solution Summary

I explain the decision of a firm to build a new factory given several factors, including expected profit, interest rates, and initial cost.

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