Charlie owes Joe $8,000 on a note that is due in five years with accumulated interest at 6%. Joe has an investment opportunity now that he thinks will earn 18%. There’s a chance, however, that it will earn as little as 4%. A bank has offered to discount the note at 14% and give Joe cash that he can invest today.
a. How much ahead will Joe be if he takes the bank’s offer and the investment does turn out to yield 18%?
b. How much behind will he be if the investment turns out to yield only 4%?