Owners of deeply indebted and chronically unprofitable small businesse

Question

Owners of deeply indebted and chronically unprofitable small businesses sometimes try to convince others to invest money in their companies. Since the money thus acquired will inevitably be used to pay off debts, rather than to expand operation, this money will not stimulate sales growth in such companies. Thus, most people are reluctant to make these investments. Surprisingly, however, such investments often earn handsome returns in the very first year they are made.

Which one of the following, if true, most helps to explain the surprising results of such investments?

(A) Investors usually choose to reinvest their returns on such investments.

(B) Expanding production in such companies would usually require more funds than would paying off debts.

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits.

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable.

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production.

GDT · Answer

(A) Investors usually choose to reinvest their returns on such investments.  Doesn't explain the discrepancy

(B) Expanding production in such companies would usually require more funds than would paying off debts.  Doesn't explain the discrepancy

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits.   Correct    It shows that by reducing the debt owed by the company, the money that would otherwise be used to pay interest on debt is given as interest to the lenders

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable.  Doesn't explain the discrepancy

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production.  Doesn't explain the discrepancy

HarshaGM · Answer

The correct answer choice is option (C).

Let us see why.

Passage Analysis

1. Owners of companies that are 
 a) In-debt (i.e. have loans to pay off)
 b) Chronically unprofitable (i.e. consistently not making profits)
 sometimes try to convince others to invest in their companies. 
2. Money obtained from such investors will be used to pay off debts => this money is not available to expand the operations => sales growth will not happen. 
i.e. this money will not result in an increase in Sales. 
3. Because of the above reason, many people are reluctant to invest in these companies. 
4. However, such investments have been observed to provide handsome returns to the investors in the very first year of investment

Question:  Logical Explanation for the surprisingly handsome return on investments

Thought Process:

We know that

Profit = Sales - Expenses

Also,

Return of Investment = (Net Profit/Investment)*100%

We know that Sales is not going to increase as a result of the money. But what if because of debts being paid off using investment money, the expenses of the firms come down.
 
So,  Sales being same, Expenses being lesser -> Higher Profit -> Higher Return on Investment

This logic definitely makes sense. Let us review the answer choices.

(A) Investors usually choose to reinvest their returns on such investments. 
Irrelevant. What investors choose to do with the returns they have obtained is not relevant to how these returns were obtained.

(B) Expanding production in such companies would usually require more funds than would paying off debts. 
Irrelevant. We already know that expansion of production is not happening with the amount received by the companies. This will not explain why returns are so good, given no production expansion.

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits.

Correct. This is exactly what we discussed above. Lower Expenses -> Higher Profits -> Higher Returns.

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable. 
Irrelevant. This only tells us again that it may be a bad idea to invest in such companies (already highlighted in the passage). It does not tell us why returns are so good when people invest in such companies.

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production. 
Irrelevant. This only tells us that if a company is struggling with regard to Sales (not growing), it should probably not devote a large share of resources to expanding production. It can instead focus, say, on building efficiency (cost cutting) with existing production. But, this statement is also not really relevant to why returns are so good when people invest in such struggling companies.

Cheers!

GmatKnightTutor · Answer

A typical discrepancy question, I daresay. We have deeply indebted businesses that are chronically unprofitable. We have investors who can later make quite a good return somehow by investing in them - EVEN THOUGH these companies are INEVITABLY going to use the money to pay off debt rather than expand production etc.

Owners of deeply indebted and chronically unprofitable small businesses sometimes try to convince others to invest money in their companies. Since the money thus acquired will inevitably be used to pay off debts, rather than to expand operation, this money will not stimulate sales growth in such companies. Thus, most people are reluctant to make these investments. Surprisingly, however, such investments often earn handsome returns in the very first year they are made.

Which one of the following, if true, most helps to explain the surprising results of such investments?

(A) Investors usually choose to reinvest their returns on such investments.
Doesn't explain how investors make a good return initially, though.

(B) Expanding production in such companies would usually require more funds than would paying off debts.
If anything this hurts the argument by saying that more funds are required to expand production. It's irrelevant.

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits.
Paying off debts....increases profits. Well, at least we got the profits. Keep.

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable.
Irrelevant. Doesn't address the paradox.

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production
This one wasn't bad, I felt. If there was little need to devote a large share of company resources to expanding production, what about all the money that was therefore 'saved' that way. I kind of went into story-mode. (C) just won out in the end and I chose it.

Some Kudos would be nice

rahat16 · Answer

Owners of deeply indebted and chronically unprofitable small businesses sometimes try to convince others to invest money in their companies. Since the money thus acquired will inevitably be used to pay off debts, rather than to expand operation, this money will not stimulate sales growth in such companies. Thus, most people are reluctant to make these investments. Surprisingly, however, such investments often earn handsome returns in the very first year they are made.

Which one of the following, if true, most helps to explain the surprising results of such investments?

PAssage analysis :
For the first year , paying of debts somehow helps chronically unprofitable small business
In long run however the investment doesn't promote sales growth and dont stimulate any returns .

(A) Investors usually choose to reinvest their returns on such investments.

(B) Expanding production in such companies would usually require more funds than would paying off debts.

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits.
 gives us a reason for high returns in first year.

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable.

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production.

unraveled · Answer

Owners of deeply indebted and chronically unprofitable small businesses sometimes try to convince others to invest money in their companies. Since the money thus acquired will inevitably be used to pay off debts, rather than to expand operation, this money will not stimulate sales growth in such companies. Thus, most people are reluctant to make these investments. Surprisingly, however, such investments often earn handsome returns in the very first year they are made.

Which one of the following, if true, most helps to explain the surprising results of such investments?

(A) Investors usually choose to reinvest their returns on such investments. - WRONG. Irrelevant.
 
(B) Expanding production in such companies would usually require more funds than would paying off debts. - WRONG. No giving any hint too so not the right answer.

(C) Paying off debts, by saving a company the money it would otherwise owe in interest, decreases the company’s overall expenses and thereby increases its profits. - CORRECT. Point blank.

(D) Banks are reluctant to lend money to any company that is already heavily in debt and chronically unprofitable. - WRONG, Irrelevant.

(E) If the sales of a company do not grow, there is usually little need to devote a large share of company resources to expanding production. - WRONG. True but not relevant in explaining what led to such results.

Answer C.

VerbalBot · Answer

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Owners of deeply indebted and chronically unprofitable small businesse

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Owners of deeply indebted and chronically unprofitable small businesse

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