Force of capital budgeting analysts at Sam Adams Ltd, concerning the drilling and production of known reserves

Question:

Force of capital budgeting analysts at Sam Adams Ltd, concerning the drilling and production of known reserves at an offshore location:

Investment in rigging equipment and related personnel costs

required to pump the oil ................ $4,900,000

Net increase in inventory and receivables associated with the

drilling and production of the reserves. Assume the investment

will be recovered at the end of the project ...................................$960,000

Net cash inflow from operations for the expected life of the reserves by year:

2006..............................................................................................$1,600,000

2007 ........................$2,880,000

2008 ........................$1,360,000

Salvage value of machinery and equipment at the

end of the well's productive life ...................$800,000

Cost of capital .......................12%


Questions:

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 2006, and the net cash inflows from operations will be received in lump sum at the end of each year. Ignore income taxes, and round answers to the nearest $1.

b. What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer!

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. Identify the significant estimates made by the task force. For each estimate, state the effect on the actual ROI (return on investment) if the estimate turns out to be less than the actual amount finally achieved.

Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at...
Internal Rate of Return
Internal Rate of Return of IRR is a capital budgeting tool that is used to assess the viability of an investment opportunity. IRR is the true rate of return that a project is capable of generating. It is a metric that tells you about the investment...
Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...
Capital Budgeting
Capital budgeting is a practice or method of analyzing investment decisions in capital expenditure, which is incurred at a point of time but benefits are yielded in future usually after one year or more, and incurred to obtain or improve the...
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Related Book For  book-img-for-question

Accounting What the Numbers Mean

ISBN: 978-0078025297

10th edition

Authors: David H. Marshall, Wayne W. McManus, Daniel F. Viele

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