Question

The following investment opportunities are available to an investment center manager: Project Initial Investment Annual Earnings A $ 800,000 $ 90,000 B 100,000 20,000 C 300,000 25,000 D 400,000 60,000 Required: a. If the investment manager is currently making a return on investment of 16 percent, which project(s) would the manager want to pursue? b. If the cost of capital is 10 percent and the annual earnings approximate cash flows excluding finance charges, which project(s) should be chosen? c. Suppose only one project can be chosen and the annual earnings approximate cash flows excluding finance charges. Which project should be chosen?

Answer 1

Answer:

Instructions are listed below

Explanation:

Giving the following information:

Projects:

A

Io= -$ 800,000

Perpetual cash= $ 90,000

B

Io= 100,000

Perpetual cash flow= 20,000

C

Io= 300,000

Perpetual CF= 25,000

D

Io= 400,000

Perpetual CF= 60,000

To find the present value of a perpetual annuity we need to use the following information:

PV= cash flow/i

A) i= 0.16

A= -800000 + (90000/0.16)= -237,500

B= -100000 + (20000/0.16)= 25,000

C= -300000 + (25000/0.16)= -143,750

D= -400000 + (60000/0.16)= -25000

Only project B is pursuable.

B) i=10%

A= 100,000

B= 100,000

C= -50,000

D= 200,000

Only project C is not pursuable. Project D has the greatest net present value.

C) With i=16% only project B should be pursued. With i=10%, project D is the best.