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 12.4%.

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	%	$ ?? million	$ ? million
   5		? million	?? million
   10		? million	?? million
   12		? million	?? million
   15		? million	? million
   17		? million	? million
   20		? million	? million

2. 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.

   ? %

3. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.4%?

   -Select-YesNo ?

4. If all available projects with returns greater than 12.4% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.4%, because all the company can do with these cash flows is to replace money that has a cost of 12.4%?

   -Select-YesNo ?

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

   -Select-YesNo ?

Answer 1

D26 x fix =IRR(D4:D24) D 2 5 7 - $ 2.06 11 12 13 14 15 16 17 18 19 A B C Cash flows Year Project A Project B D ifference ТА В ТА-В 0$ (11.60) $ (11.60) $ 1 $ 13.92 $ 2.0612 $ 2 $ - $ 2.0612 $ 3 $ - $ 2.0612 $ 4 $ - $ 2.0612 $ 5 $ $ 2.0612 $ 6 $ $ 2.0612 $ 7 $ - $ 2.0612 $ 8 $ - $ 2.0612$ 9 $ - $ 2.0612 $ 10 $ - $ 2.0612 $ 11 $ - $ 2.0612$ 12 $ - $ 2.0612 $ 13 $ $ 2.0612 $ 14 $ $ 2.0612$ 15 $ $ 2.0612 $ 16 $ - $ 2.0612 $ 17 $ - $ 2.0612$ 18 $ - $ 2.0612 $ 19 $ - $ 2.0612$ 20 $ - $ 2.0612 $ colululululululuto I E F G [email protected]% Present value Project A Project B AxC BxC 1.000 $ (11.60) $ (11.60) 11.86 0.890 $ 12.38 $ 1.83 (2.06) 0.792 $ - $ 1.63 (2.06) 0.704 $ - $ 1.45 (2.06) 0.627 $ - $ 1.29 (2.06) 0.557 $ $ 1.15 (2.06) 0.496 $ $ 1.02 (2.06) 0.441 $ - $ 0.91 (2.06) 0.393 $ $ 0.81 (2.06) 0.349 $ $ 0.72 (2.06) 0.311 $ - $ 0.64 (2.06) 0.276 $ $ 0.57 (2.06) 0.246 $ - $ 0.51 (2.06) 0.219 $ - $ 0.45 (2.06) 0.195 $ $ 0.40 (2.06) 0.173 $ $ 0.36 (2.06) 0.154 $ . $ 0.32 (2.06) 0.1371 $ - $ 0.28 (2.06) 0.122 $ - $ 0.25 (2.06) 0.109 $ - $ 0.22 (2.06) 0.097 $ - $ 0.20 21 22 23 24 25 26 IRR 20.00% 17.00% $ 0.78 $ 3.42 16.41% NPV = (Crossover rate) 27

D F G NPV-A H NPV-B 29 b) Rate AB Select both Plan A and Plan B Yes Yes 30 c) 31 d) 32 33 34 0.00% $ 2.32 $ 29.62 5.00% $ 1.66 $ 14.09 10.00% $ 1.05 $ 5.95 12.00% $ 0.83 $ 3.80 15.00% $ 0.50 $ 36.88 17.00% $ 8.95 $ 36.25 20.00% $ - $1.56

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