Question

In: Finance

You own factory A and factory B. The next cash flow for eachfactory is expected...

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?

	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.

Expert Solution

Value of Factory A = Annual Cash flow / Cost of Capital

= 19300 / 0.035

= 551,428.57

Cost of Capital of factory B

Value of Factory B = Annual Cash flow / Cost of Capital

545000 = 19900 / Cost of Capital

Cost of Capital = 19900 / 545000

Cost of Capital = 3.65%

Value of Factory A = 551,428.57

Value of Factory B = 545000

Cost of Capital of factory A = 3.5%

Cost of Capital of factory B = 3.65%

Value of Factory A is higher and risk is low.

Option B is correct. Factory A is more valuable than factory B and factory B is more risky than factory A

jeff jeffy answered 2 years ago

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