Question

NPV PROFILES: TIMING DIFFERENCES

An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $11 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 12.7%.

a.Construct NPV profiles for Plans A and B. Round your answers to two decimal places. Round your answers to two decimal places. Do not round your immediate calculations. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. If the amount is zero enter "0". Negative should be indicated by minus sign.

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

b. Identify each project's IRR. Round your answers to two decimal places.

c. Project A ___________%

d. Project B ___________%

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

______________%

f. Is it logical to assume that the firm would take on all avaialble independent, average-risk projects with returns greater than 12.7%?

_______________________

I all available projects with returns greater than 72% have been undertaken, does thiss mean that cash flows from past investments have an opportunity cost of only 12.7%, because all the company can do with these cash flows is to replace money that has a cost of 12.7%?

____________________

Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?

Answer 1

1)