Question

Asked Jan 30, 2019

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Investing 100,000 in additional raw materials, mostly palladium, should allow cryogenic concepts to increase production and earn an additional 112,000 next year. This payoff could cover the investment, plus a 12% return. Palladium is traded in commodity markets. The CFO has studied the history of returns from investments in palladium and believes that investors in the precious metal can reasonably expect a 15% return. what is the opportunity cost of capital? Is Cryogenic proposed investment in palladium a good idea? Why or why not?

I believe the Opportunity cost of capital is 12% the minimum acceptable rate of return. I think that it would be a good deal because whether it's return on investment of 12 or 15% it's more than 100,000. However I'm confused by this question, the only example I got was in relation to whether a firm was reinvesting money or giving the money back to shareholders. In the example if the firm had reinvested money into their project it would have been a 20% increase, if they let the share holders have the money and invest in it on their own it would have been 10%. The minimum rate of return would have been 10.

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Step 1

* Opportunity Cost of Capital:* It is termed as an investment’s incremental return that a business relinquishes when it chooses to utilize its reserves or assets for an in-house project, as opposed to investing money in a marketable security. Hence, if the projected return for the in-house project is less than the expected return on a marketable security, some would not invest into the in-house project, accepting this is the main reason for the choice. This difference among the two returns on the two projects is called as opportunity cost of capital.

Step 2

**The example for opportunity cost of capital is shown below:**

If Company X is planning to build a new warehouse, it needs $10,000,000 to build the new warehouse. However Company X does not have the required amount to build the warehouse. So it decides to borrow the required amount from Bank Y in the form of debt. Bank Y decides to assist Company X and necessitates a required return of 10% for the mentioned amount. In this circumstance the opportunity cost of capital of Company X will be considered as 10%.

Step 3

**The reasons on whether the proposed investment a good idea is as follows:**

The analysis suggests that it may not be considered as an effective investment. Because the opportunity cost of capital in this circumstance is 15% which is higher than the expected retu...

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