FIN – THE DRILLAGO CO. IS INVOLVED IN SEARCHING FOR LOCATIONS

Question:
The Drillago Co. is involved in searching for locations in which to drill for oil. The firm’s current project requires an initial investment of $15 million and has an estimated life of 10 years. the expected future cash inflows for the project are as shown.

Year 1 Cash inflows $600,000
year 2 cash inflows 1,000,000
year 3 cash inflows 1,000,000
year 4 cash inflows 2,000,000
year 5 cash inflows 3,000,000
year 6 cash inflows 3,500,000
year 7 cash inflows 4,000,000
year 8 cash inflows 6,000,000
year 9 cash inflows 8,000,000
year 10 cash inflows 12,000,000

The firm’s current cost of capital is 13%.

TO DO:

Create a spreadsheet to answer the following:
A.Calculate the project’s internal rate of return (NPV). Is the project acceptable under the IRR technique? Explain.

B.Calculate the project’s internal rate of return (IRR). Is the project acceptable under the IRR technique? Explain.

C. In this case, did the two methods produce the same results? Generally, is there a preference between the NPV and IRR techniques? Explain.

d. Calculate the payback period for the project. If the firm usually accepts projects that have payback periods between 1 and 7 years, is this project acceptable?