A Company Has Identified the Following Investments as Looking Promising

question 80

Multiple Choice

A company has identified the following investments as looking promising. Each requires an initial investment of $1.2 million. Which is the best investment?

• A) a perpetuity that generates a cash flow at the end of year 1 of $100,000, has a growth rate of 1.25%, and a cost of capital of 11.0%
• B) a perpetuity that generates a cash flow at the end of year 1 of $800,000, has a growth rate of 2.25%, and a cost of capital of 11.8%
• C) an investment that generates a cash flow of $400,000 at the end of each of the next five years, when the cost of capital is 6.1%
• D) an investment that generates a cash flow of $200,000 at the end of each of the next ten years, when the cost of capital is 6.1%

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Definitions:

Cost Behaviour

The way in which a cost changes in relation to changes in business activity levels.

Direct Material Costs

The expenses for raw materials that are directly traceable to the manufacturing of a specific product.

Units Produced

The total number of complete units manufactured or finished in a given period.

Fixed Costs Per Unit

Fixed costs per unit decrease as production volume increases, reflecting the spread of costs that do not change with the level of output over a larger number of units.