Question

An oil-drilling company must choose between two mutually exclusive extraction projects, and each costs $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 12.1%.

1. 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 "0". Negative value should be indicated by a 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

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

   Project A ____ %

   Project B ____%

   Find the crossover rate. Round your answer to two decimal places. Do not round your intermediate calculations.
   ____%
2. 
   
3. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.1%?      [YES or NO]

If all available projects with returns greater than 12.1% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.1%, because all the company can do with these cash flows is to replace money that has a cost of 12.1%?               [YES OR NO]


Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?                          [YES or NO]

Answer 1