An investor has the opportunity to invest in four new retail stores. The amount

Question

An investor has the opportunity to invest in four new retail stores. The amount that can be invested in each store, along with the expected cash flow at the end of the first year, the growth rate of the concern, and the cost of capital is shown for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose?          

A.      IA. initial investment: $100,000; cash flow in year 1: $12000; Growth Rate 1.25%; Cost of Capital: 9.0%

B.      B. initial investment: $90,000; cash flow in year 1: $10000; Growth Rate 1.50%; Cost of Capital: 9.0%

C.      C.initial investment: $80,000; cash flow in year 1: $8000; Growth Rate 1.75%; Cost of Capital: 8.0%

D.      D. initial investment: $60,000; cash flow in year 1: $6000; Growth Rate 2.50%; Cost of Capital: 7.5%

Explanation / Answer

So just compare the NPVs:

Use CF/(r-g)

-100000+12000/(.09-.0125)=54,800 ish
-90000+10000/(.09-.015)=43,000 ish

-80000+8000/(.08-.0175)=48,0000 is

-60000+6000/(.075-.025)=65,000 ish

So the last one, D.

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