5. Andi Acquisition, Inc. is considering the purchase of Kristina Covington Comp
ID: 2801102 • Letter: 5
Question
5.
Andi Acquisition, Inc. is considering the purchase of Kristina Covington Company. The acquisition would require an initial investment of $190,000, but Andi?s after-tax net cash flow would increase by $50,000 per year and remain at this new level forever. Assume a cost of capital of 20 percent. Should Andi buy Kristina Company?
Yes, because the NPV = $60,000
No, because cost of capital < IRR
Yes, because the NPV = $50,000
Yes, because the IRR < the cost of capital
None of the above.
I.Yes, because the NPV = $60,000
II.No, because cost of capital < IRR
III.Yes, because the NPV = $50,000
IV.Yes, because the IRR < the cost of capital
V.None of the above.
Explanation / Answer
Initial investment cost = $190,000
Annual cash flows = $50,000
Cost of capital = 20%
NOV = Present value of cash inflows - Initial investment cost
= $50,000 / 20% - $190,000
= $250,000 - $190,000
= $60,000
Since NPV is positive, it is better to select the project.
Note : Present value of cash inflows with a term forever = Annual cash inflow/ Cost of capital
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