Question

An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $11.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $13.92 million. Under Plan B, cash flows would be $2.0612 million per year for 20 years. The firm's WACC is 12.4%. 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.

Discount rate:

0%

5%

10%

12%

15%

17%

20%

Identify each project's IRR.

Find the crossover rate.

Answer 1

Year	Cash Flows	Difference	[email protected]%	Present Value
	Project A	Project B	A-B	C	Project A	Project B
A	B	A*C	B*C
0	(11.60)	(11.60)	-	1.000	(11.60)	(11.60)
1	13.92	2.0612	11.86	0.890	12.38	1.83
2	-	2.0612	(2.06)	0.792	-	1.63
3	-	2.0612	(2.06)	0.704	-	1.45
4	-	2.0612	(2.06)	0.627	-	1.29
5	-	2.0612	(2.06)	0.557	-	1.15
6	-	2.0612	(2.06)	0.496	-	1.02
7	-	2.0612	(2.06)	0.441	-	0.91
8	-	2.0612	(2.06)	0.393	-	0.81
9	-	2.0612	(2.06)	0.349	-	0.72
10	-	2.0612	(2.06)	0.311	-	0.64
11	-	2.0612	(2.06)	0.276	-	0.57
12	-	2.0612	(2.06)	0.246	-	0.51
13	-	2.0612	(2.06)	0.219	-	0.45
14	-	2.0612	(2.06)	0.195	-	0.40
15	-	2.0612	(2.06)	0.173	-	0.36
16	-	2.0612	(2.06)	0.154	-	0.32
17	-	2.0612	(2.06)	0.137	-	0.28
18	-	2.0612	(2.06)	0.122	-	0.25
19	-	2.0612	(2.06)	0.109	-	0.22
20	-	2.0612	(2.06)	0.097	-	0.20
IRR	20.00%	17.00%	16.41%(Crossover rate)	NPV	0.78	3.42

Both the projects can be selected

Rate	NPV-A	NPV-B
0%	2.32	29.62
5%	1.66	14.09
10%	1.05	5.95
12%	0.83	3.8
15%	0.50	36.88
17%	8.95	36.25
20%	-	-1.56