A company has identified the following investments as looking promising. Each re

Question

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 10%

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 12%

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%

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%

Explanation / Answer

a) value= 100000 / 0.1 - 0.0125 = 1142857.14

b) value = 800000 / ( 0.12 - 0.0225 ) = 8205128.21

c) 400000 / 1.06 + ... + 400000 / 1.06^5 = 1684945.51

d) 200000 / 1.06 + ... + 200000 / 1.06^10 = 1472017.41

Hence b) is the best investment as it gives $8,205,128.21

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