SADDA Oil Company has the opportunity to buy a larger pump for its oil field for $10,000. if the firm buys the pump, it will increase cash flows by $720,000 in year one, pumping the field dry. The cash flows for year 2 will be $820,000 less with the new pump than without it, since the field will be dry. In short, the cash flows are (negative numbers in parentheses):
Year 0 1 2
Flow (100,000) 720,000 (820,000)
The firms cost of capital is 12 percent. An IRR was calculated for the project, and it was 15.75 percent. Should SADDA Oil accept this project? Why or why not?
Draw a graph of the NPV of this project at various costs of capital, ranging from zero percent to 8000 percent. Does that graph provide you any useful information in deciding whether to accept the project or not?