Reference no: EM132660657

Your friend, Sam had a rental property rented to a travel agent. The property used to generate rental revenues of $100000 per annum. Due to COVID19, the travel agent shut down the business and moved out of the property. Instead of renting it again to a new tenant, Sam is planning for an investment opportunity. He plans to use the property for producing toilet tissues and hand sanitizer to take advantage of recently increased demand for these products in the stir of COVID-19. To set up the new business, it will cost him $5m now ( equipment including set up), and he will have to take a bank loan for the whole amount with an interest rate of 6% per annum. The investment will generate an expected cash flow of $800000 per year for ten years. An alternative investment with similar risk generates an expected return of 8% per annum. Your friend seeks your assistance to understand the effect of finance cost and opportunity cost in his capital budgeting decision making.

Explain to your friend the impact of these two costs in his project evaluation. Compare these two projects and offer a brief summary on which option is better and why?