Economics analysis and technical applications General Electric is considering ex

Question

Economics analysis and technical applications General Electric is considering expanding their oil and gas exploration project in Alaska. The cash flow for one phase of the project involving pretotech, an oil and gas servicing company, is shown. Given reinvestment rate of 14% per year for excess funds and 10 % per year for borrowing rate for extra funds, determine: given MARR = 12% Year Net cash flow 0 -60,0000 1 +2,700,000 2 30,000 3 +4,850,067 4 11,000 5 +53,000 a) How many number of ROR values is expected and why? b) Calculate the external rate of return. c) Is the project economically viable?

Explanation / Answer

a) As there are three negative cash flows followed by a posititve cash flow, we can expect 3 ROR values. As Rate of return is calculated on the investments.

b)

To calculate ROR, the positive cash flows are reinvested at reinvestment rate to time 5 while negative cash flows are discounted at cost of capital .

Future Value of positive cash flows =2,700,000*(1+14%)^4 + 4850,067*(1+14%)^2 + 53000 = $ 10,916,339.51

Present Value of cash out flows = -600,0000 - 30,000/(1.10)^2 - 11,000/(1.1)^4 = -5,967,693.464

ERR = (10,916,339.51/5967693.464)^1/5 - 1 = 12.83 %

c)

As ERR> MARR =12% ,t he project is economically viable.

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