Canadian Metal, Mining, and Petroleum Company are analyzing two projects for possible investment. Only one investment will be made. The first project is an oildrilling project in Alberta at a cost of $500 million that will produce $100 million per year in Years 5 through 10 and $200 million per year in Years 11 through 20. The second project is an expansion of an aluminum smelter in Mapletree, Quebec, and will cost $500 million and will produce $87 million per year for Years 2 through 20.
The cost of capital is 12 percent.
a. Which investment should be made?
b. If the oil-well project justifies an extra 4 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of flows, does the investment decision change?