The Following Data Have Been Collected by Capital Budgeting Analysts

question 14

Essay

The following data have been collected by capital budgeting analysts at Condel Brothers Oil Co.concerning the drilling and production of known reserves at an off-shore location:
$\begin{array}{lrr} \text { Investment in rigging equipment and related personnel costs } &\\ \text { required to pump the oil } &\$5,300,000\\ \text { Net increase in inventory and receivables associated with the } &\\ \text { drilling and production of the reserves. Assume this investment will} &\\ \text { be recovered at the end of the project } &1,200,000\\ \text { Net cash inflow from operations for the expected life of the} &\\ \text { reserves for years: } &\\ \text { Year 1 } &2,000,000\\ \text {Year 2 } &3,600,000\\ \text { Year 3 } &1,700,000\\ \text { Salvage value of machinery and equipment at the end of the well's } &\\ \text {productive life } &1,000,000\\ \text { Cost of capital } &18\%\\\end{array}$

(a.)Calculate the net present value of the proposed investment in the drilling and production operation.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.

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