Answered step by step
Verified Expert Solution
Question
1 Approved Answer
An oll company executive is considering Investing $ 1 1 . 8 million In one or both of two wells: well 1 is expected to
An oll company executive is considering Investing $ million In one or both of two wells: well is expected to produce oll worth $
million a year for years; well is expected to produce $ million for years. These are real Inflationadjusted cash flows.
The beta for producing wells is The market risk premium is the nominal riskfree interest rate is and expected inflation is
The two wells are intended to develop a previously discovered oll field. Unfortunately there is still a chance of a dry hole in each
case. A dry hole means zero cash flows and a complete loss of the $ million investment.
Ignore taxes and make further assumptions as necessary.
a What is the correct real discount rate for cash flows from developed wells? Do not round Intermedlate calculatlons. Enter your
answer as a percent rounded to decimal places.
b The oll company executive proposes to add percentage points to the real discount rate to offset the risk of a dry hole. Calculate
the NPV of each well with this adjusted discount rate. Negatlve answers should be Indlcated by a minus sign. Do not round
Intermedlate calculations. Enter your answers in dollars not in millions and round your answers to the nearest whole dollar
amount.
c Are the NPVs calculated in Part B the correct NPVs If they are correct, reenter the NPVs from your answers in Part B for both wells.
If they are incorrect, recalculate the NPVs to the correct values for both wells. Do not round Intermedlate calculations. Enter your
answers in dollars not in millions and round your answers to the nearest whole dollar amount.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started