NPV profiles: timing differences An oil drilling company must choose between two
ID: 2773840 • Letter: N
Question
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $11 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $13.2 million. Under Plan B, cash flows would be $1.9546 million per year for 20 years. The firm's WACC is 12.6%.
Construct NPV profiles for Plans A and B. Round your answers to two decimal places. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55.
Discount Rate Plan A Plan B
0
5
10
12
15
17
20
Identify each project's IRR. Round your answers to two decimal places. Project A % Project B %
Find the crossover rate. 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 12.6%?
If all available projects with returns greater than 12.6% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.6%, because all the company can do with these cash flows is to replace money that has a cost of 12.6%?
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?
Explanation / Answer
IRR of Project A=20% Project B=17%
Yes, if capital is not a problem then the firm can take all projects that have more than 12.6% return.
No, it has nothing to do with opportunity cost, it is the cost of capital for the company.
WACC can be used as the minimum return criteria for undertaking any project. Because anyways the company has to pay for its capital.
Discount rate Plan A Plan B 0 2.2 28.09 5 1.57 13.36 10 1 5.64 12 .79 3.6 15 .48 1.23 17 .28 0 20 0 -1.48Related Questions
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