A communications company installs cable to service a new area.They estimate the cost of installing the cable is $17 million,but they will receive a cash flow of $1.4 million per year indefinitely.The net present value (NPV)of this investment at a cost of capital of 6.5% indicates that this is a worthwhile investment.By how much would the cost of capital have to increase for the NPV to be zero?
A)0.83%
B)1.74%
C)3.25%
D)5.37%
E)8.24%

Question

Quizplus · Accepted Answer

The NPV is zero when the cost of capital equals the rate of return. The rate of return is calculated as the annual cash flow divided by the initial investment: $1.4 million / $17 million = 0.0824 or 8.24%. The current cost of capital is 6.5%, so it would need to increase by 1.74% to reach 8.24%.

A Communications Company Installs Cable to Service a New Area