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 4.3 percent and is expected to produce annual cash flows of $19,100 forever. Factory B is worth $455,000 and is expected to produce annual cash flows of $18,800 forever. Which assertion is true?

a.	Factory A is more valuable than factory B and factory A is more risky than factory B
	b.	Factory A is more valuable than factory B and factory B is more risky than factory A
	c.	Factory B is more valuable than factory A and factory A is more risky than factory B
	d.	Factory B is more valuable than factory A and factory B is more risky than factory A
	e.	Factory A and factory B either have the same value, the same level of risk, or both the same value and level of risk.

Answer 1

Annual cash flows for factory A = $ 19,100

Cost of capital = 4.3%

Current worth of factory A = 19,100/ 4.3% (as it is a perpetuity)

= $ 444,186.05

Annual cash flows of factory B = $ 18,800

Current worth of B = $ 455,000

As B has higher worth(value) despite lower quantity of cash flows per year, it has a much lower risk than A.

So, the answer is

C) Factory B is more valuable than factory A and factory A is more risky than factory B