An oil company is considering changing the size of a small pump that currently is in operation in an oil field. If the current pump is kept, it will extract 50% of the known crude oil reserve in the first year of operation and the remaining 50% in the second year. A pump larger than the current pump will cost $1.6 million, but it will extract 100% of the known reserve in the first year. The total oil revenues over the two years are the same for both pumps: $20 million. The advantage of the large pump is that it allows 50% of the revenue to be realized a year earlier than the small pump. The two options are summarized as follows: Item                          current pump                    Larger Pump Investment, year 0                $0                    $1.6 millionRevenue, year 1                   $10 million          $20 millionRevenue, year 2                      $10 million          $0If the firm's MARR is known to be 20%, what do you recommend, according to the IRR criterion?

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An oil company is considering changing the size of a small pump that currently is in operation in an oil field. If the current pump is kept, it will extract 50% of the known crude oil reserve in the first year of operation and the remaining 50% in the second year. A pump larger than the current pump will cost $1.6 million, but it will extract 100% of the known reserve in the first year. The total oil revenues over the two years are the same for both pumps: $20 million. The advantage of the large pump is that it allows 50% of the revenue to be realized a year earlier than the small pump. The two options are summarized as follows:

Item                          current pump                    Larger Pump

Investment, year 0                $0                    $1.6 million
Revenue, year 1                   $10 million          $20 million
Revenue, year 2                      $10 million          $0
If the firm's MARR is known to be 20%, what do you recommend, according to the IRR criterion?

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