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abc big oil company
the abc big oil company is considering two mutually exclusive plans for extracting oil on property for which it has mineral rights. Both plans call for the expenditure of $10mm to drill development wells. Under plan a, all the oil will be extracted in 1 year, producing a cash flow at t=1 of $12mm, while plan b would have cash flows of $1.75mm per year for 20 years.
a) What are the annual incremental cash flows that will be available to the firm if it undertakes Plan B rather than Plan A? b) If the firm accepts Plan A, and then invests the extra cash generated at the end of year 1, what rate of return (reinvestment rate) would cause the cash flows from reinvestment to equal the cash flows of Plan B? |
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