NPV profiles for Plan A and B, IRR of the two plans and approximate crossover rate and IRR of each plan. Introduction: Net Present Value (NPV): It is a method under capital budgeting which includes the calculation of net present value of the project in which the company is investing. The calculation is done by calculating the difference between the value of cash inflow and value of cash outflow after considering the discounted rate. Internal Rate of Return (IRR): It refers to the rate of return that is computed by the company to make a decision regarding the selection of a project for investment. This rate provides the basis for selection of projects with lower cost of capital and rejection of project with higher cost of capital. Crossover Rate: It refers to the discounted rate at which the NPV of the two projects becomes equal. It is a cost of capital of the project.

Question

An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $12 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t 1 of $14.4 million. Under Plan B, cash flows would be $2.1323 million per year for 20 years. The firm's WACC is 12.8%. a. Construct NPV profiles for Plans A and B. 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 values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places. Discount Rate NPV Plan A NPV Plan B 0% $ million $ million 5 million million 10 million million 12 million I million 15 million 17 20 million million million million million Identify each project's IRR. Do not round intermediate calculations. Round your answers to two decimal places. Project A: % Project B: % Find the crossover…

Answer 1

Question

Chapter 11, Problem 15P

a.

Summary Introduction

To prepare: NPV profiles for Plan A and B, IRR of the two plans and approximate crossover rate and IRR of each plan.

Introduction:

Net Present Value (NPV):

It is a method under capital budgeting which includes the calculation of net present value of the project in which the company is investing. The calculation is done by calculating the difference between the value of cash inflow and value of cash outflow after considering the discounted rate.

Internal Rate of Return (IRR):

It refers to the rate of return that is computed by the company to make a decision regarding the selection of a project for investment. This rate provides the basis for selection of projects with lower cost of capital and rejection of project with higher cost of capital.

Crossover Rate:

It refers to the discounted rate at which the NPV of the two projects becomes equal. It is a cost of capital of the project.

b.

Summary Introduction

To explain: Whether it is logical for a firm to accept all the projects with returns greater than 12% WACC and whether this implies that the WACC is the correct reinvestment rate of assumption for the project cash flows.

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An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $12 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t 1 of $14.4 million. Under Plan B, cash flows would be $2.1323 million per year for 20 years. The firm's WACC is 12.8%. a. Construct NPV profiles for Plans A and B. 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 values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places. Discount Rate NPV Plan A NPV Plan B 0% $ million $ million 5 million million 10 million million 12 million I million 15 million 17 20 million million million million million Identify each project's IRR. Do not round intermediate calculations. Round your answers to two decimal places. Project A: % Project B: % Find the crossover…

An oil-drilling company must choose between two mutually exclusive extraction projects, and each requires an initial outlay at t = 0 of $13 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.6 million. Under Plan B, cash flows would be $2.31 million per year for 20 years. The firm's WACC is 11.3%. Construct NPV profiles for Plans A and B. 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 values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to two decimal places.

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