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Question(s) / Instruction(s):

A task force of capital budgeting analysts at Seger Ltd. collected the following data concerning the drilling and production of known petroleum reserves at an offshore location:                                         

  Investment in rigging equipment and related personnel costs

    required to pump the oil                                                                                          $4,720,000          

  Net increase in inventory and receivables associated with the

    drilling and production of the reserves. Assume this investment

    will be recovered at the end of the project.                                                    915,000

  Net cash inflow from operations for the expected life of the reserves, by year:                                               

      2010                1,565,000            

      2011                2,975,000            

      2012                1,340,000            

  Salvage value of machinery and equipment at the

    end of the well's productive life                           895,000

  Cost of capital                                                                 10%

Required:

(a)          Using the Table 6-4, calculate the net present value of the proposed investment in the drilling and production operation. Assume that the investment will be made at the beginning of 2010, and the net cash inflows from operations will be received in a lump sum at the end of each year.

(b)          What will the internal rate of return on this investment be relative to the cost of capital?

(c)           Differences between estimates made by the task force and actual results would have an effect on the actual rate of return on the project. For each estimate, state the effect on the actual ROI if the estimate turns out to be less than the actual amount finally achieved.

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