Click here to read the eBook NPV Profiles NPV PROFILES TIMIN

Click here to read the eBook: NPV Profiles NPV PROFILES: TIMING DIFFERENCES An oil-drilling company must choose between two mutually exclusive extraction projects, and each costs $11.4 millin. Under Plan A, all the ol would be extracted in 1 year, producing a cash flow at t-1 of $13.68 million. Under Plan B, cash flows would be $2.0257 million per year for 20 years. The firm\'s WACC is 12.2%. a. Construct NPV profiles for Plans A and B. Round your answers to two decimal places Do not round your intermediate calculations. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. If an amount is zero enter \"O\". Negative value should be indicated by a minus sign. 10 12 15 17 million 20 million Identify each project\'s IRR. Round your answers to two decimal places. Do not round Project A Project B Find the crossover rate. Round your answer to two decimal places. Do not round your 30 889 2 3 4 6

Solution

a) Plan A Plan B Discount Rate NPV Plan A NPV Plan B Year Cash Flow Cash flow Difference 0.00% $2.28 Million $29.11 Million 0 -11.4 -$11.40 $0.00 5.00% $1.63 Million $13.84 Million 1 13.68 $2.03 -$11.65 10.00% $1.04 Million $5.85 Million 2 0 $2.03 $2.03 12.00% $0.81 Million $3.73 Million 3 0 $2.03 $2.03 15.00% $0.50 Million $1.28 Million 4 0 $2.03 $2.03 17.00% $0.29 Million $0.00 Million 5 0 $2.03 $2.03 20.00% $0.00 Million -$1.54 Million 6 0 $2.03 $2.03 NPV = - Cash outflow + NPV(discount rate, Payments) 7 0 $2.03 $2.03 8 0 $2.03 $2.03 Identify each project\'s IRR. Round your answers to two decimal places. 9 0 $2.03 $2.03 Project A (Using IRR function) 20.00% 10 0 $2.03 $2.03 Project B (Using IRR Function 17.00% 11 0 $2.03 $2.03 12 0 $2.03 $2.03 Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.2%? 13 0 $2.03 $2.03 Yes 14 0 $2.03 $2.03 The cost of capital (12.2%) is less than the crossover rate 16.41% the two methods lead to different project selections—a conflict exists. When a conflict exists the NPV method must be used. 15 0 $2.03 $2.03 16 0 $2.03 $2.03 If all available projects with returns greater than 12.2% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.2%, because all the company can do with these cash flows is to replace money that has a cost of 12.2%? 17 0 $2.03 $2.03 Yes 18 0 $2.03 $2.03 Does this imply that the WACC is the correct reinvestment rate assumption for a project\'s cash flows? 19 0 $2.03 $2.03 Yes 20 0 $2.03 $2.03 NPV method assumes CFs are reinvested at the WACC b) Cross over Rate 16.41%