A natural gas energy company must choose between two mutually exclusive extraction projects, and each costs...

60.1K

Verified Solution

Question

Finance

A natural gas energy company must choose between two mutuallyexclusive extraction projects, and each costs $12 million. UnderPlan D, all the natural gas would be extracted in 1 year, producinga cash flow at t = 1 of $14.4 million. Under Plan E, cash flowswould be $2.1 million per year for 20 years. The firm’s WACC is13%.
a. Construct NPV profiles for Plans D and E, identify eachproject’s IRR, and show the approximate crossover rate.
b. Is it logical to assume that the firm would take on allavailable independent, average-risk projects with returns greaterthan 13%? If all available projects with returns greater than 13%have been undertaken, does this mean that cash flows from pastinvestments have an opportunity cost of only 13% because all thecompany can do with these cash flows is to replace money that has acost of 13%? Does this imply that the WACC is the correctreinvestment rate assumption for a project’s cash flows?
Please show all calculations.

Answer & Explanation Solved by verified expert

3.6 Ratings (433 Votes)

SEE THE IMAGE ANY See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

A natural gas energy company must choose between two mutuallyexclusive extraction projects, and each costs $12 million. UnderPlan D, all the natural gas would be extracted in 1 year, producinga cash flow at t = 1 of $14.4 million. Under Plan E, cash flowswould be $2.1 million per year for 20 years. The firm’s WACC is13%.a. Construct NPV profiles for Plans D and E, identify eachproject’s IRR, and show the approximate crossover rate.b. Is it logical to assume that the firm would take on allavailable independent, average-risk projects with returns greaterthan 13%? If all available projects with returns greater than 13%have been undertaken, does this mean that cash flows from pastinvestments have an opportunity cost of only 13% because all thecompany can do with these cash flows is to replace money that has acost of 13%? Does this imply that the WACC is the correctreinvestment rate assumption for a project’s cash flows?Please show all calculations.