AsifCo has natural gas fields located in several counties in rural Oklahoma. Asi

Question

AsifCo has natural gas fields located in several counties in rural Oklahoma. AsifCo has two proposals for removing the natural gas each costing $10 million for all associated costs including drilling equipment, labor, and transportation to the market. In Plan A, all the natural gas will be extracted within one year generating an expected year end cash flow of $12 million. Plan B has cash flows of $1,750,000 per year for the next 20 years. AsifCo has a hurdle rate of 12%. Which way should AsifCo go and why?

Explanation / Answer

Plan A : NPV = CF0+CF1/(1+i) = -10M+12M/(1+12%) =0.7143M

Plan B: PV of CFs = 1.75M*PVIFA(12%,20)

= 1.75M*7.4694 = 13.0715M

So NPV of B = CF0+PV of CFs = -10M+13.0715 =3.0715M

As NPV of Plan B is higher, Plan B is better

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