An investor has the opportunity to invest in five new retail stores. The amount
ID: 2456217 • Letter: A
Question
An investor has the opportunity to invest in five new retail stores. The amount that can be invested in each store, the expected cash flow at the end of the first year, the growth rate of the cash flows, and the cost of capital is indicated for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose? Show your work
A) Initial investment: $100,000; Cash flow in year 1: $12,000; Growth Rate: 1.25%; Cost of Capital: 9.0%
B) Initial investment: $90,000; Cash flow in year 1: $10,000; Growth Rate: 1.50%; Cost of Capital: 9.0%
C) Initial investment: $80,000; Cash flow in year 1: $8000; Growth Rate: 1.75%; Cost of Capital:8.0%
D) Initial investment: $60,000; Cash flow in year 1: $6000; Growth Rate: 2.50%; Cost of Capital: 7.5%
E) Initial investment: $50,000; Cash flow in year 1: $5,000; Growth rate: 2.00%; Cost of Capital: 7.0%
Explanation / Answer
A B C D E Initial investment 100,000 90,000 80,000 60,000 50,000 Cash flow in year 1 12,000 10,000 8,000 6,000 5,000 Growth 1.25 1.50 1.75 2.50 2.00 Cost of capital 9.00 9.00 8.00 7.50 7.00 0.0125 0.0150 0.0175 0.0250 0.0200 0.0900 0.0900 0.0800 0.0750 0.0700 1+g= 1.0125 1.0150 1.0175 1.0250 1.0200 r-g= 0.0775 0.0750 0.0625 0.0500 0.0500 Perpetuity Value = 156,774 135,333 130,240 123,000 102,000 Net cashflow 56,774 45,333 50,240 63,000 52,000 Conclusion: Porject D with highest net cashflow could be selected Perpetuity Value = ( CFn x (1+ g) ) / (R - g) CFn = Cash Flow in the Last Individual Year Estimated, in this case Year 10 cash flow g = Long-Term Growth Rate R = Discount Rate, or Cost of Capital, in this case cost of equity
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