A task force of capital budgeting analysts at Morrison Ltd. collected the following data concerning the drilling and production of known petroleum reserves at an offshore location: Table 6-4 (Use appropriate factor(s) from the table provided. Round the PV factors to 4 decimals.)
Investment in rigging equipment and related personnel costs
required to pump the oil |
$7,000,000 |
Net increase in inventory and receivables associated with the
drilling and production of the reserves. Assume this investment
will be recovered at the end of the project |
1,230,000 |
| Net cash inflow from operations for the expected life of the reserves, by year: |
|
| 2013 |
2,030,000 |
| 2014 |
3,630,000 |
| 2015 |
1,730,000 |
Salvage value of machinery and equipment at the
end of the well's productive life |
1,030,000 |
| Cost of capital |
6% |
Required:
a. Calculate the net present value of the proposed investment in the drilling and production operation. Assume that the investment will be made at the beginning of 2013, and the net cash inflows from operations will be received in a lump sum at the end of each year (Ignore income taxes).
b. Differences between estimates made by the task force and actual results would have an effect on the actual rate of return on the project. For each estimate, state the effect on the actual ROI if the estimate turns out to be less than the actual amount finally achieved.
A task force of capital budgeting analysts at Morrison Ltd. collected the following data concerning the drilling and production of known petroleum reserves at an offshore location: above table (Use appropriate factor(s) from the table provided. Round the PV factors to 4 decimals.)
Required:
a. Calculate the net present value of the proposed investment in the drilling and production operation. Assume that the investment will be made at the beginning of 2013, and the net cash inflows from operations will be received in a lump sum at the end of each year (Ignore income taxes).
b. What will the internal rate of return on this investment be relative to the cost of capital?
c. Differences between estimates made by the task force and actual results would have an effect on the actual rate of return on the project. For each estimate, state the effect on the actual ROI if the estimate turns out to be less than the actual amount finally achieved.