A firm is contemplating an advertising campaign that promise

A firm is contemplating an advertising campaign that promises to yield $120 one year from now for $100 spent now. Explain why the firm should or should not undertake the advertising campaign.

Hint: Calculate the present value for r = 15%, r = 20% and r = 25%

Solution

If r=15%, Present value=120/(1+.15)=104.3 If r=20%,Present value=120/(1+.20)=100 If r=25%,Present value=120/(1+.25)=96 This implies if r<20%,Present value should be more than 100$ to get yield 120$.So firm should not undertake the advertising campaign if r<20%.