1. Suppose you extract and produce oil barrels. You are considering renting an oil field for one year only. The rent of the field is $18 million, paid today with certainty. Revenues are received in one year, and depend on the oil price. There is a 50% probability that the revenues will be $60 million, and 50% probability that they will be $40 million. Distribution, storage and other fees are also incurred one year from now, and are equal to $5 million plus 50% of the revenues. Assume that the risk-free rate is 3%, the market risk premium is 7%, and the beta of an investment in oil extraction is 0.75. Use the CAPM to calculate the required rate of return. a. Is this project attractive? Should you rent the field? b. Suppose now that you have the option to rent the oil field one more year at the end of the first year. However, in the second year the revenues are an average of 70% of the first year revenues, and the rent costs 120% as much as the first year. The distribution, storage and other fees in the second year remain the same, i.e. $5 million plus 50% of the revenues. Does anything about your previous analysis change? If so, what? Should you rent the field? c. Suppose the potential revenues from the oil field become riskier. With 50% probability, they will be $90 million, and with 50% probability, $10 million. Note that the expected cash flows of the oil field have not changed. Does this change make the rent of the field a more or less attractive project? (Or does it have no effect at all?) Explain your answer briefly. Assume the discount rate does not change, i.e., the additional risk is purely idiosyncratic. Would an increase in the risk of cash flows for the one-year-only rent project have a similar effect? Why or why not?