Problem 19, Chapter 13, Foundations of Financial Management

Question: Canadian Metal, Mining and Petroleum Company are analyzing two projects for possible investment. Only one investment will be made. The first project

is an oil drilling 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 ca;pital because of its riskiness and relative uncertainty of flows, does the investment decision change?