Question
Paul Ltd is evaluating its gas industry to include an underground extraction. Ken, the companys geologist, has just finished his analysis of the gas site.
Paul Ltd is evaluating its gas industry to include an underground extraction. Ken, the companys geologist, has just finished his analysis of the gas site. He has estimated that the gas would be productive for five years. Ken has taken an estimate of gas deposited to John, the companys financial manager, John has been asked by management to perform an analysis of the new gas extraction and present her recommendation on whether the company should go for this project.
Johns estimation reveals that if the company commence operation, it will cost $600 million today, while it will have a cash outflow of $50 million six years from today in costs associated with closing the gas site and restoring the gas cite and restoring the gas production facility. The expected cash flows from each year from the gas extraction are shown in the table given below. Paul ltd. Has a 12% required rate of return on all of its gas operations.
Year | Cash Flow |
1 | ($600 000 000) |
1 | 70 000 000 |
2 | 150 000 000 |
3 | 182 000 000 |
4 | 251 000 000 |
5 | 180 000 000 |
6 | (50 000 000) |
Required -:
- What is the project payback period along with your calculations?
- What is the net present value (NPV) of this project?
- If the companys acceptance is based on NPV, should this project be accepted? Why?
- What is the IRR (Internal rate of return) of this project?
- If you apply IRR, should the project be accepted? why?
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