Problem 11-15 NPV profiles: timing differences An oil drilling company must choo
ID: 2654923 • Letter: P
Question
Problem 11-15
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.2 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $14.64 million. Under Plan B, cash flows would be $2.1678 million per year for 20 years. The firm's WACC is 12.6%.
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.
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.
%
Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.6%?
-Select-yesnoItem 18
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%?
-Select-yesnoItem 19
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?
-Select-yesnoItem 20
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Discount Rate NPV Plan A NPV Plan B 0% $ {C} million $ {C} million 5 $ {C} million $ {C} million 10 $ {C} million $ {C} million 12 $ {C} million $ {C} million 15 $ {C} million $ {C} million 17 $ {C} million $ {C} million 20 $ {C} million $ {C} millionExplanation / Answer
SOLUTION Calculation of NPV at Discount Rate 0% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 0% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1 $14,640,000 $2,167,800 2 $2,167,800 1 $2,167,800 3 $2,167,800 1 $2,167,800 4 $2,167,800 1 $2,167,800 5 $2,167,800 1 $2,167,800 6 $2,167,800 1 $2,167,800 7 $2,167,800 1 $2,167,800 8 $2,167,800 1 $2,167,800 9 $2,167,800 1 $2,167,800 10 $2,167,800 1 $2,167,800 11 $2,167,800 1 $2,167,800 12 $2,167,800 1 $2,167,800 13 $2,167,800 1 $2,167,800 14 $2,167,800 1 $2,167,800 15 $2,167,800 1 $2,167,800 16 $2,167,800 1 $2,167,800 17 $2,167,800 1 $2,167,800 18 $2,167,800 1 $2,167,800 19 $2,167,800 1 $2,167,800 20 $2,167,800 1 $2,167,800 NPV $2,440,000 $31,156,000 Calculation of NPV at Discount Rate 5% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 5% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.05 $13,942,857.14 $2,064,571.43 2 $2,167,800 1.1025 $1,966,258.50 3 $2,167,800 1.1576 $1,872,627.15 4 $2,167,800 1.2155 $1,783,454.42 5 $2,167,800 1.2763 $1,698,528.02 6 $2,167,800 1.3401 $1,617,645.74 7 $2,167,800 1.4071 $1,540,614.99 8 $2,167,800 1.4775 $1,467,252.37 9 $2,167,800 1.5513 $1,397,383.21 10 $2,167,800 1.6289 $1,330,841.15 11 $2,167,800 1.7103 $1,267,467.76 12 $2,167,800 1.7959 $1,207,112.16 13 $2,167,800 1.8856 $1,149,630.62 14 $2,167,800 1.9799 $1,094,886.31 15 $2,167,800 2.0789 $1,042,748.87 16 $2,167,800 2.1829 $993,094.16 17 $2,167,800 2.2920 $945,803.96 18 $2,167,800 2.4066 $900,765.68 19 $2,167,800 2.5270 $857,872.07 20 $2,167,800 2.6533 $817,021.02 NPV $1,742,857.14 $14,815,579.58 Calculation of NPV at Discount Rate 10% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 10% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.1 $13,309,090.91 $1,970,727.27 2 $2,167,800 1.21 $1,791,570.25 3 $2,167,800 1.331 $1,628,700.23 4 $2,167,800 1.4641 $1,480,636.57 5 $2,167,800 1.6105 $1,346,033.24 6 $2,167,800 1.7716 $1,223,666.59 7 $2,167,800 1.9487 $1,112,424.17 8 $2,167,800 2.1436 $1,011,294.70 9 $2,167,800 2.3579 $919,358.82 10 $2,167,800 2.5937 $835,780.74 11 $2,167,800 2.8531 $759,800.68 12 $2,167,800 3.1384 $690,727.89 13 $2,167,800 3.4523 $627,934.44 14 $2,167,800 3.7975 $570,849.49 15 $2,167,800 4.1772 $518,954.08 16 $2,167,800 4.5950 $471,776.44 17 $2,167,800 5.0545 $428,887.67 18 $2,167,800 5.5599 $389,897.88 19 $2,167,800 6.1159 $354,452.62 20 $2,167,800 6.7275 $322,229.66 NPV $1,109,090.91 $6,255,703.43 Calculation of NPV at Discount Rate 12% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 12% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.12 $13,071,428.57 $1,935,535.71 2 $2,167,800 1.2544 $1,728,156.89 3 $2,167,800 1.4049 $1,542,997.22 4 $2,167,800 1.5735 $1,377,676.09 5 $2,167,800 1.7623 $1,230,067.94 6 $2,167,800 1.9738 $1,098,274.94 7 $2,167,800 2.2107 $980,602.63 8 $2,167,800 2.4760 $875,538.06 9 $2,167,800 2.7731 $781,730.41 10 $2,167,800 3.1058 $697,973.58 11 $2,167,800 3.4785 $623,190.70 12 $2,167,800 3.8960 $556,420.27 13 $2,167,800 4.3635 $496,803.81 14 $2,167,800 4.8871 $443,574.83 15 $2,167,800 5.4736 $396,048.96 16 $2,167,800 6.1304 $353,615.14 17 $2,167,800 6.8660 $315,727.80 18 $2,167,800 7.6900 $281,899.82 19 $2,167,800 8.6128 $251,696.27 20 $2,167,800 9.6463 $224,728.81 NPV $871,428.57 $3,992,259.89 Calculation of NPV at Discount Rate 15% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 15% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.15 $12,730,434.78 $1,885,043.48 2 $2,167,800 1.3225 $1,639,168.24 3 $2,167,800 1.5209 $1,425,363.69 4 $2,167,800 1.7490 $1,239,446.69 5 $2,167,800 2.0114 $1,077,779.73 6 $2,167,800 2.3131 $937,199.76 7 $2,167,800 2.6600 $814,956.32 8 $2,167,800 3.0590 $708,657.67 9 $2,167,800 3.5179 $616,224.06 10 $2,167,800 4.0456 $535,847.01 11 $2,167,800 4.6524 $465,953.92 12 $2,167,800 5.3503 $405,177.32 13 $2,167,800 6.1528 $352,328.10 14 $2,167,800 7.0757 $306,372.26 15 $2,167,800 8.1371 $266,410.67 16 $2,167,800 9.3576 $231,661.45 17 $2,167,800 10.7613 $201,444.74 18 $2,167,800 12.3755 $175,169.34 19 $2,167,800 14.2318 $152,321.16 20 $2,167,800 16.3665 $132,453.18 NPV $530,434.78 $1,368,978.77 Calculation of NPV at Discount Rate 17% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 17% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.17 $12,512,820.51 $1,852,820.51 2 $2,167,800 1.3689 $1,583,607.28 3 $2,167,800 1.6016 $1,353,510.49 4 $2,167,800 1.8739 $1,156,846.57 5 $2,167,800 2.1924 $988,757.76 6 $2,167,800 2.5652 $845,092.10 7 $2,167,800 3.0012 $722,300.94 8 $2,167,800 3.5115 $617,351.23 9 $2,167,800 4.1084 $527,650.62 10 $2,167,800 4.8068 $450,983.44 11 $2,167,800 5.6240 $385,455.93 12 $2,167,800 6.5801 $329,449.51 13 $2,167,800 7.6987 $281,580.78 14 $2,167,800 9.0075 $240,667.33 15 $2,167,800 10.5387 $205,698.58 16 $2,167,800 12.3303 $175,810.75 17 $2,167,800 14.4265 $150,265.60 18 $2,167,800 16.8790 $128,432.13 19 $2,167,800 19.7484 $109,771.06 20 $2,167,800 23.1056 $93,821.41 NPV $312,820.51 -$125.97 Calculation of NPV at Discount Rate 20% Year Cash Flows Plan A Cash Flows Plan B FVIF @ 20% PV of Cash Flows Plan A PV of Cash Flows Plan B 0 ($12,200,000) ($12,200,000) 1 ($12,200,000) ($12,200,000) 1 $14,640,000 $2,167,800 1.2 $12,200,000.00 $1,806,500.00 2 $2,167,800 1.44 $1,505,416.67 3 $2,167,800 1.728 $1,254,513.89 4 $2,167,800 2.0736 $1,045,428.24 5 $2,167,800 2.4883 $871,190.20 6 $2,167,800 2.9860 $725,991.83 7 $2,167,800 3.5832 $604,993.19 8 $2,167,800 4.2998 $504,161.00 9 $2,167,800 5.1598 $420,134.16 10 $2,167,800 6.1917 $350,111.80 11 $2,167,800 7.4301 $291,759.84 12 $2,167,800 8.9161 $243,133.20 13 $2,167,800 10.6993 $202,611.00 14 $2,167,800 12.8392 $168,842.50 15 $2,167,800 15.4070 $140,702.08 16 $2,167,800 18.4884 $117,251.73 17 $2,167,800 22.1861 $97,709.78 18 $2,167,800 26.6233 $81,424.82 19 $2,167,800 31.9480 $67,854.01 20 $2,167,800 38.3376 $56,545.01 NPV $0.00 -$1,643,725.05 Calculation of Crossover Rate Year Cash Flows Plan A Cash Flows Plan B Cumulative Cash Flows 0 ($12,200,000) ($12,200,000) $0 1 $14,640,000 $2,167,800 $12,472,200 2 $2,167,800 ($2,167,800) 3 $2,167,800 ($2,167,800) 4 $2,167,800 ($2,167,800) 5 $2,167,800 ($2,167,800) 6 $2,167,800 ($2,167,800) 7 $2,167,800 ($2,167,800) 8 $2,167,800 ($2,167,800) 9 $2,167,800 ($2,167,800) 10 $2,167,800 ($2,167,800) 11 $2,167,800 ($2,167,800) 12 $2,167,800 ($2,167,800) 13 $2,167,800 ($2,167,800) 14 $2,167,800 ($2,167,800) 15 $2,167,800 ($2,167,800) 16 $2,167,800 ($2,167,800) 17 $2,167,800 ($2,167,800) 18 $2,167,800 ($2,167,800) 19 $2,167,800 ($2,167,800) 20 $2,167,800 ($2,167,800) Crossover Rate 16.41% Yes. Since the crossover rate is higher than the WACC this project is accepted Yes. The WACC is the correct reinvestment rate assumption for a projects cash flows.