Question

An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $12.8 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.36 million. Under Plan B, cash flows would be $2.2744 million per year for 20 years. The firm's WACC is 12.6%.

1. Construct NPV profiles for Plans A and B. 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 "0". Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places.

   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

   Identify each project's IRR. Do not round intermediate calculations. Round your answers to two decimal places.

   Project A: %

   Project B: %

   Find the crossover rate. Do not round intermediate calculations. Round your answer to two decimal places.

   %

2. 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?

Answer 1