Economics help!! Please!!?

Question

Let R = rate of return and I = interest rate. Why are these important in making investment decisions? Does opportunity cost play a role? Explain.

Answer 1

Rate of return and interest rate are very important since you need them to see whether you would like to invest in one output over others. You can calculate with Present value and use discount rate to see whether it is good investment of not. And if you have other options other than investing in certain output, you can compare to see which comes out with best return at the end.

I don't really remember how to use rate of return, but I can find it if you need it.
For the interest rate, you can use for example:

" The library information system problem contains two annuities: the annual benefits of $100,000 per year for five years, which we refer to as annuity A1, and the annual costs of $20,000 per year for five years, which we refer o as annuity A2.

you can find Present Value of A1 and A2 by using
a=(1-(1+i)^(n)) / i
therefore, PV(A1)= 100,000 x (1-(1+0.07)^(-5)) / 0.07 = $410,020
Compare to PV(A2)= 20,000 x 4.1002 = $82,004

Therefore, your benefit A1, five years later, is 410,020 compare to your cost $82,004.
Instead of calculating your benefit and cost at today's dollar term you can calculate annuity so that you can get true dollar value at the end of your term. Simply way to look at it is that your one dollar won't be one dollar next year, it will be less. Therefore, if you calculate your return with interest rate, you get your return at the end of the term(n). But you money is not worth the same at the end of the year so you calculate annuity. With your true or real return, calculate your opportunity cost by using initial capitals to other investments and their returns. Than you will see what you will forego and what you will gain by investing certain output.

Answer 2

There are many ways to think about this.
Both rate of return and interest rate can be either positive or negative. They depend on whether you are gaining/losing or lending/borrowing.
For example, you borrow $100 from bank at interest rate of 6% for an investment, where interest rate is -5%. And the rate of return on this investment is 10%. Then you make 4% profit after deducting bank interest.

Opportunity cost does play a role in making investment decisions. You can think of it as profit difference between two investments. It shows you which investment decision having better profit return.
If you took an investment with rate of return at 12%, you would make a profit of 6% rather than 4%.
Alternatively, if you can borrow $100 from someone at interest rate of 5% rather than from the bank, you will make 5% profit in the investment at 10% return rate. Then the opportunity cost is the 1% difference.

Answer 3

Rate of return on your investment is what money you will be getting back so... of course it is important. Interest rate depends on what sort of interest rate you are talking about. Did you borrow the money to invest? Or are you talking about an interest rate you are charging for the money you invested? Both are big factors.

Opportunity cost is more of a concept thing. What did you have to give up to use the money to invest? The opportunity cost of your investment might be a house that perhaps could have a similar return on the investment. OR the opportunity cost might be a new car that depreciates. It's all in the perspective of the investor.

Hope that helps