37. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year and then expected NPV of the project if postponed by one year is:

A.+10,000,000

B.+25,000,000

C.+5,000,000

D.none of the above

NPV(oil price = $70/bbl) = +50,000,000

NPV(oil price = $40 \/bbl) = -10,000,000/1.1 = -9,090,909 (reject) NPV(oil price = $10/bbl) = 0

Expected NPV = (0.5)(0) + (0.5)(50,000,000) = 25,000,000

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