Question

Green Caterpillar Garden Supplies Inc. is considering a one-year project that requires an initial investment of $600,000; however, in raising this capital, Green Caterpillar will incur an additional flotation cost of 2%. At the end of the year, the project is expected to produce a cash inflow of $840,000. The rate of return that Green Caterpillar expects to earn on the project after its flotation costs are taken into account is a. 29.80 b.22.35 c.37.25 d.33.53

Answer 1

Compute the investment after flotation cost, using the equation as shown below:

Net investment = Additional investment*(1 + Flotation cost rate)

                         = $600,000*(1 + 0.02)

                         = $612,000

Hence, the net investment after floatation cost is $612,000.

Compute the rate of return (ROR), using the equation as shown below:

ROR = (Cash inflows – Net investment)/ Net investment

         = ($840,000 - $612,000)/ $612,000

         = $228,000/ $612,000

         = 37.25%

Hence, ROR will be 37.25%.