Light Sweet Petroleum, Inc., is trying to evaluate a generation project with the

Question

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

What is the NPV for the project if the company requires a return of 12 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

This project has two IRR's, namely  percent and  percent, in order from smallest to largest. (Note: If you can only compute one IRR value, you should input that amount into both answer boxes in order to obtain some credit.) (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

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

Explanation / Answer

(a - i)

NPV is the sum of present value of all cash inflows and outflows.

So,

NPV ($) = - 39,600,000 + (63,600,000 / 1.12) - [12,600,000 / (1.12)2]

= - 39,600,000 + 56,785,714.29 - 10,044,642.86

= 7,141,071.43

(a - ii)

Since NPV > 0, project should be accepted.

(b)

IRR is that discount rate which makes NPV = 0.

- 39,600,000 =  (63,600,000 / r) - [12,600,000 / (r)2] Where r: IRR

- 396 = (636 / r) - (126 / r2)

- 396 r2 = 636r - 126

396 r2 + 636r - 126 = 0

66r2 + 106r - 21 = 0

This is a quadratic equation, solving which we obtain**:

r = 17.83% or r = - 178.44 (Which is unacceptable as a discount rate).

IRR = - 178.44% and 17.83%

** Note: Value of X from a quadratic equation of the form AX2 + BX + C = 0 is:

[- B ± (B2 – 4AC)] / 2A

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