Evaluate projects which project should the company prefer

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Reference no: EM133433804

Question: Star Energy is an oil and gas exploration and development company located in Western Australia. The company drills wells to find out significant oil and gas deposits. Currently, the company is considering two drilling opportunities with different production potentials. The first is the WA region Drills (WARD), and the second is the NT region Drills (NTRD). The WARD's cash inflows are much more promising, but the project requires a large initial investment compared to the NTRD. The projects have different life periods. The expected cash flows for the two projects are as follows:
Year WARD NTRD
In NZ$ In NZ$
Year 0 (Initial investment) -8,000,000 -5,000,000
Year 1 1,800,000 1,000,000
Year 2 1,700,000 1,000,000
Year 3 1,450,000 1,050,000
Year 4 1,400,000 1,100,000
Year 5 1,450,000 1,150,000
Year 6 1,320,000 1,000,000
Year 7 1,600,000 900,000
Year 8 1,530,000 930,000
Year 9 1,600,000
Year 10 900,000

Required:

3.1 Calculate the payback period for each of the two projects.

3.2 Based on the calculated payback periods, which of the two projects appears to be the best alternative? In determining these two projects' value creation potential, is the payback period method ignoring anything important? Explain.

3.3 If the company uses an 8.5% discount rate to evaluate the present values of these two projects, what is the NPV of these two projects? Based on your NPV calculations, suggest your preferred project.

3.4 If the company uses the internal rate of return (IRR) method to evaluate the projects, which project should the company prefer? Explain your answer using relevant IRR calculations.

Reference no: EM133433804

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