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Computation of the present value of each project using annual compounding rate.
Instructions:
Blue Mesa Oil Company is considering two projects. The As Is Project involves drilling for oil using existing technology. Given the estimated reserves, this project is expected to produce $15.6 million at the end of year 3. Due to the relatively low level of risk involved, management's required rate of return is 12.5 percent.
The Bedrock project involves using new technology to drill for oil from a field located beneath bedrock. Given the higher risk involved, this project must provide a rate of return of 14.6 percent. If the new technique works, the project is expected to produce $12.4 million in only 2 years. Compute the present value of each project using annual compounding, and report on the relative values and the difference between the two.
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