Suppose that an oil well is expected to produce 100,000 barrels of oil during its first production year. However, its subsequent production (yield) is expected to decrease by 10% over the previous year’s production. The oil well has a proven reserve of 1,000,000 barrels.
(a) Suppose that the price of oil is expected to be $100 per barrel for the next seven years. What would be the present worth of the anticipated revenue stream at an interest rate of 12% compounded annually over the next seven years?
(b) Suppose that the price of oil is expected to start at $100 per barrel during the first year, but to increase at the rate of 5% over the previous year’s price. What would be the present worth of the anticipated revenue stream at an interest rate of 12% compounded annually over the next seven years?
(c) Assume the conditions of part (b). After three years of production, you decide to sell the oil well. What would be the fair price for the oil well based on four more years of production?