Question

Light Sweet Petroleum, Inc., is trying to evaluate an exploration project with the following cash flows:

Year Cash Flow

0 -$39,000,000

1 63,000,000

2 -12,000,000

If the company requires a 12 percent return on its investments, should it accept this project?

Yes, the IRR is below the 12% hurdle rate

No, the IRR is above the 12% hurdle rate

Cannot determine because there are multiple IRRs

Yes, the NPV is positive

No, the NPV is negative

Answer 1

NPV = PV of cash in flow - Initial investment

Initial Investment = $39,000,000

PV of cash in flow for first year at 12% hurdle rate = 63,000,000 * 0.893 = 56,259,000

PV of cash in flow for second year at 12% hurdle rate = (12,000,000) * 0.797 = (9,564,000)

Total PV of cash in flow = 56,259,000 + (9,564,000) = 46,695,000

NPV = 46,695,000 - 39,000,000 = 7695000

NPV = 7695000 So NPV IS POSITIVE AND WE AN ACCEPT THIS PROJECT.

Right answer is , Yes the NPV is positive

A project with NPV positive and IRR > hurdle rate is acceptable and project with NPV negative and IRR < hurdle rate is rejected. Here first option says that the project is acceptable because IRR is below than hurdle rate that option itself is wrong and so there is no need of calculation for IRR. So the first three options are wrong. As the NPV is positive Option four is right and fifth option is wrong.