20. Both Dow Chemical Company, a large natural gas user, and Superior Oil, a maj
ID: 2794059 • Letter: 2
Question
20. Both Dow Chemical Company, a large natural gas user, and Superior Oil, a major natural gas producer, are thinking of investing in natural gas wells near Houston. Both are all equity financed companies. Dow and Superior are looking at identical projects. They've analyzed their respective investments, which would involve an initial cash investment followed by positive expected cash flows in the future. The investment and future cash inflows would be the same for both firms. No debt would be used to finance the projects. Both companies estimate that their project would have an NPV of $1,000,000 at an I 8% discount rate but a negative NPV of-$1,100.000 at a 22% discount rate. Dow has a beta of 1.25 while Superior has a beta of .75. The expected risk premium on the market is 8% and risk-free bonds are yielding 12%, which of the following is true? a. b. c. d. Both companies should invest Neither company should invest Dow should invest but Superior shouldn't Superior should invest but Dow shouldn'tExplanation / Answer
Both the companies have 18% cost of capital. Superior company is closer to the pure play as it is into this business. The cost of capital is 18% and NPV of $1000000 for both the companies. The project has positive NPV for both the companies. Hence, both the companies should proceed for the project.
Answer is ‘a’.
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