You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:
Years
Cash Flow
0
â100
1â10
+15
a.
On the basis of the behavior of the firmâs stock, you believe that the beta of the firm is 1.4. Assuming that the rate of return available on risk-free investments is 4% and that the expected rate of return on the market portfolio is 12%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $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 12%.
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. %
Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12%? -Select-yesnoItem 18
If all available projects with returns greater than 12% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12%, because all the company can do with these cash flows is to replace money that has a cost of 12%? -Select-yesnoItem 19
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows? -Select-yesnoItem 20
Present Value of an Annuity of $1 at Compound Interest
Year
6%
10%
12%
15%
20%
1
0.943
0.909
0.893
0.870
0.833
2
1.833
1.736
1.690
1.626
1.528
3
2.673
2.487
2.402
2.283
2.106
4
3.465
3.170
3.037
2.855
2.589
5
4.212
3.791
3.605
3.352
2.991
6
4.917
4.355
4.111
3.784
3.326
7
5.582
4.868
4.564
4.160
3.605
8
6.210
5.335
4.968
4.487
3.837
9
6.802
5.759
5.328
4.772
4.031
10
7.360
6.145
5.650
5.019
4.192
Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects, assuming a minimum rate of return of 15%. Use the present value tables appearing above.
a. Determine the net present values of the two projects.
Blending Equipment
Computer System
Total present value of cash flows
$
$
Less amount to be invested
$
$
Net present value
$
$
b. Determine the present value indices of the two projects. If required, round the present value index to two decimal places.
Present Value Index
Blending Equipment
Computer System
Which project should be selected? (If both present value indices are the same, either project will grade as correct.) Computer System
Feedback
a. For each investment, determine the present value of the cash flows at 15% for 5 years, Exhibit 5. Use the residual value of the Blending Equipment to equate useful lives (Exhibit 2). Subtract the amount to be invested.
b. Divide the total present value of the cash flows by the amount to be invested. What do the present value indexes indicate about the net present values?
