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