Q1. You are a senior manager at an automobile company. In an effort to offer a...

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Finance

Q1. You are a senior manager at anautomobile company. In an effort to offer a full menu of auto andgas products, your firm is considering an oil exploration project.The CEO has selected the manager of the company’s truck division tooversee the project, and has asked you to evaluate whether thecompany should proceed with the exploration or not.
To help you evaluate the project, yourassociate gives you the following information:
Company
Equity beta
D/(D+E)
General American Oil
1.6
0.05
Lousiana Land & Exploration
1.2
0.20
Mesa Petroleum
2.6
0.15
Murphy Oil
1.7
0.30
Natomas Oil
1.8
0.45
Oceanic Exploration
1.5
0.24
Superior Oil
1.3
0.13
Should you also ask the associate for similar information oncar manufacturers? On truck manufacturers? On automobile companies?Why or why not?
Based on the information you have available, calculate anappropriate discount rate assuming for the project that risk freerate is 4%, the expected market return is 8%, and the corporate taxrate is 20%. Assume that the oil exploration project is 84% equityfinanced.(please show me the detail calculation and steps. )(50points)
assume cost of debt (return on debt) = risk free rate.

Answer & Explanation Solved by verified expert

3.9 Ratings (704 Votes)

a As per the concept of Capital Budgeting the financial viability and eventual selection of a prospective project should be done after considering the initial investment and the future cashflows that it generates in such a way that it leads to positive Net Present Value NPV The NPV for a project depends not only on the initial investment and future cashflows but also on the discount rate used to discount the future cashflows The discount rate in essence would depend on the nature of the project the choice of gearing proportion of equity contribution and debt financing by the company the risk perception of See Answer

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Company	Equity beta	D/(D+E)
General American Oil	1.6	0.05
Lousiana Land & Exploration	1.2	0.20
Mesa Petroleum	2.6	0.15
Murphy Oil	1.7	0.30
Natomas Oil	1.8	0.45
Oceanic Exploration	1.5	0.24
Superior Oil	1.3	0.13