An oil company is drilling a series of new wells on the perimeter of a producing oil field. About 40% of the new wells will be dry. Even if a new well strikes oil, there is still uncertainty about the amount of oil produced: 30% of new wells which strike oil produce only 3,000 barrels a week; 70% produce 40,000 barrels a week.

(a) Forecast the annual revenues from a new perimeter well. Use a future oil price of $100 per barrel.

(b) A geologist proposes to discount the cash flows of the new wells at 10% to offset the risk of drilling but not finding oil. The oil company's normal cost of capital is 5%. Does this proposal make sense? Explain briefly why or why not