Question

You own factory A and factory B. The next cash flow for each factory is expected in 1 year. Factory A has a cost of capital of 3.5 percent and is expected to produce annual cash flows of $19,300 forever. Factory B is worth $545,000 and is expected to produce annual cash flows of $19,900 forever. Which assertion is true

Answer 1

Answer: See Explanation

Explanation:

First, we have to calculate the worth of factory A which will be:

= Cash flow / Cost of capital

= $19300 / 3.5%

= $19300 / 0.035

= $551428.57

= $551429

Cost of capital of Factory B = Cash flow / Worth

= $19,900 / $545,000

= 0.0365

= 3.65%

Cost of capital of Factory A = 3.5%

Cost of capital of Factory B = 3.65%

Worth of factory A = $551429

Worth of Factory B = $545,000

Therefore, factory A is more valuable than Factory B and Factory B is more risky than Factory A.