Carter & Co

question 89

Essay

Carter & Co. are trying to decide which of two investments they should consider. The following information is available:
Each investment is expected to have a useful life of 5 years.
(a) What is the rate of return on average investment of each investment?
(b) What is the payback period of each investment?
$$\begin{array} { l r r } & \text { Investment } \mathrm { A } & \text { Investment B } \\\text { Cost } & \$ 400,000 & \$ 600,000 \\\text { Salvage value } & \$ 0 & \$ 40,000 \\\text { Annual cash flow } & \$ 104,000 & \$ 160,000\end{array}$$

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Definitions:

Optimal Capital Structure

The ideal mix of debt and equity financing that minimizes a company's cost of capital and maximizes shareholder value.

Weighted Average Cost of Capital

A calculation of a firm's cost of capital that weights each category of capital proportionally, including equity and debt.

Market Price

The current value at which an asset or service can be bought or sold in the marketplace.

Financial Leverage

Taking on borrowed money to magnify the possible profits of an investment.