You are considering a purchase of an oil pipeline in Texas. The pipeline will generate a $2 million cash return over the coming year and useful life of the pipeline is expected to be 20 years. The pipelines operating costs are negligible, and it is expected to last for a long time. Unfortunately, the volume of oil shipped is declining, and cash flows are expected to decline by 4% per year. The discount rate is 13%. Asking price of the pipeline is $19,500,000.

QUESTIONS

1. Calculate the payback period, internal rate of return, net present value, and the profitability index of the oil pipeline.
2. What is the discounted payback period? (The discounted payback rule asks, How many years does the project have to last in order for it to make sense in terms of net present value?)
3. Based on your analysis, should you buy the pipeline?