The Ewert Exploration Company is considering two mutually exclusive plans for ex

Question

The Ewert Exploration Company is considering two mutually exclusive plans for extracting oil on property for which it has mineral rights. Both plans call for the expenditure of $11 million to drill development wells. Under Plan A, all the oil will be extracted in 1 year, producing a cash flow at t = 1 of $11.5 million; under Plan B, cash flows will be $1.5 million per year for 20 years.

a) What are the annual incremental cash flows that will be available to Ewert Exploration if it undertakes Plan B rather than Plan A? year 1 =? Years 2-20 =? (Hint: Subtract Plan A's flows from B's.)

b)If the company accepts Plan A and then invests the extra cash generated at the end of Year 1, what rate of return (reinvestment rate) would cause the cash flows from reinvestment to equal the cash flows from Plan B? Round your answer to two decimal places.

c) Identify each project's IRR. Round your answers to two decimal places.

d) Indicate the crossover rate. Round your answer to two decimal places.

e)Suppose a firm

Explanation / Answer

Answer:

Annual incremental cash flows: (Plan B - Plan A)

For year 1 = ($1.5 million -$11.5 million) = $10 Million

For Year 2 to 20 = ($1.5 million -0) = $1.5 Million

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