Homework SourseNPV profiles timing differences An oil drilling company must
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.12 million. Under Plan B, cash flows would be $2.2389 million per year for 20 years. The firm\'s WACC is 12.4%. 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.
a.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.
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.
______%
b. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.4%?
YES OR NO
If all available projects with returns greater than 12.4% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.4%, because all the company can do with these cash flows is to replace money that has a cost of 12.4%?
YES OR NO
Does this imply that the WACC is the correct reinvestment rate assumption for a project\'s cash flows?
YES OR NO
| Discount rate | NPV Plan A | NPV Plan B |
| 0% | $_____million | $_____million |
| 5 | $_____million | $_____million |
| 10 | $_____million | $_____million |
| 12 | $_____million | $_____million |
| 15 | $_____million | $_____million |
| 17 | $_____million | $_____million |
| 20 | $_____million | $_____million |
Solution
b. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.4%?
YES
If all available projects with returns greater than 12.4% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.4%, because all the company can do with these cash flows is to replace money that has a cost of 12.4%?
NO
Does this imply that the WACC is the correct reinvestment rate assumption for a project\'s cash flows?
YES
