Problem 11-15 NPV profiles: timing differences An oil drilling company must choo
ID: 2735935 • 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 $12.4 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $14.88 million. Under Plan B, cash flows would be $2.2034 million per year for 20 years. The firm's WACC is 12.8%.
Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.8%?
-Select-yesnoItem 18
If all available projects with returns greater than 12.8% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.8%, because all the company can do with these cash flows is to replace money that has a cost of 12.8%?
-Select-yesnoItem 19
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?
-Select-yesnoItem 20
Problem 11-15
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.4 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $14.88 million. Under Plan B, cash flows would be $2.2034 million per year for 20 years. The firm's WACC is 12.8%.
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 $ millionIdentify 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 12.8%?
-Select-yesnoItem 18
If all available projects with returns greater than 12.8% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.8%, because all the company can do with these cash flows is to replace money that has a cost of 12.8%?
-Select-yesnoItem 19
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows?
-Select-yesnoItem 20
Explanation / Answer
Plan A IRR = 20%
Plan B IRR = 17%
Yes, firm can take the projects with returns greater than 11.9%.
WACC is the rate which a project should derive in order to be viable. Hence, it is the minimum cost that a project should earn.So, we it can be called a reinvestment rate as this is what a firm must earn in order to honour the stakeholders.So, it is essentially a parameter that a return should justify.
Initial Investment 12400000 WACC 11.9%