NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.12 million. Under Plan B, cash flows would be $2.2389 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. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55.
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.
Project A _____ %
Project B______ %
Find the crossover rate. Round your answer to two decimal places.
_____%
b. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.2%? Yes or No
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%? Yes or No
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows? Yes or No
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.12 million. Under Plan B, cash flows would be $2.2389 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. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55.
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.
Project A _____ %
Project B______ %
Find the crossover rate. Round your answer to two decimal places.
_____%
b. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.2%? Yes or No
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%? Yes or No
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows? Yes or No