Your company wants to buy an oil pipeline which will generate a $2 million in after tax operating cash flow over the coming year. The pipeline oil flow is expected to last for 25 years at which time your company will need to remove the pipeline and repair the land at a cost of $7 million. Your company will need to pay legal and other acquisition cost of $1.4 million in addition to the purchase price to acquire the pipeline. Your company will also need to pay Public Utility Commission license fees every five years (starting in year 6 and ending in year 25 - year one has been prepaid by the seller) of $100,000 and increasing each year at $3,000 per year. Unfortunately, the volume of oil shipped is declining, and after tax operating cash flows are expected to decline by 5 percent per year. Your company's WACC is 12 percent. Your company's tax rate is 30 percent. Ignore depreciation.
a. What is the PV of the pipeline's total cash flows?
b. What is the IRR of the cash flows?
c. Are both the NPV and IRR reliable? Why or why not?
The solution determines the PV of a pipeline's total cash flows. The IRR of the cash flows are determined.