Question

An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $11.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $13.92 million. Under Plan B, cash flows would be $2.0612 million per year for 20 years. The firm's WACC is 12.1%.

Construct NPV profiles for Plans A and B. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. If an amount is zero, enter "0". Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places.

Discount Rate NPV Plan A NPV Plan B

0

5

10

12

15  

17

20

Identify each project's IRR. Do not round intermediate calculations. Round your answers to two decimal places.

Project A: %

Project B: %

Find the crossover rate. Do not round intermediate calculations. Round your answer to two decimal places.

%

Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.1%?

If all available projects with returns greater than 12.1% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.1%, because all the company can do with these cash flows is to replace money that has a cost of 12.1%?

Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?

Answer 1