CDE H . 1 ser Exploration, Inc is considering an investment in a project that is expected to have a five-year life. The investment would require the Company to drill a well at ac lion. Digger's hurdle rate is 20 percent. expected outcomes as a result of the drilling are: h volume: 50% probability could produce up to 725,000M MBtus each year for five years edium volume: 30% probability could produce up to 550,000M MBtus each year for five years y hole: 20% probabilty the well is sucessful, the Company would have to make a decision as to whether to build a small or large processing plant. A large processing plant would cost $1,000,000 to anstruct and could process up to 710,000 MMBtus each year for five years. A small processing plant would cost $500,000 to construct and could process up to 525,000 MMB ear for five years. The amount of gas that can be sold is also dependent on the favorability of the market. If the well proves to be good, the Company could sell up to 710,000 MMBtus each yea ve years whereas a poor market will limit the Company's sales to an estimated 450,000 MMBtus each year for five years. The probabilities of the market type are as follows High volume (Good Market): 75% Medium volume (Poor Market): 25% Finally, the price received is also dependent on the favorability of the market. The Company believes it will receive $2.75 per MMBtu in a good market but only $2.40 per MME in a poor market. Required: 1. Calculate the NPVs for Options 1,2,3. & 4. 2. Construct a decision tree, in good form, that lists the 10 possible outcomes. 3. What is your recommendation e. should the Company drill the well? If so, what size of a processing plant do you recommend? What is the expected value of your recommendation? Amount Probability Period PVOA of $1 Item Capital costs Drill well Build large processing plant Build small processing plant 20.00% 3,000,000 1,000,000 500,000 Finandal Factors Table FV of $1 FVOA of $ 1 1.000000 1.200000 1.000000 1.440000 2.200000 1.728000 3.6-40000 2.073600 5:368000 2.488320 7.441600 PV of $ 1 1.000000 0.833333 0.694444 0.578704 0.482253 0.401878 0.833333 1.527778 2.106481 2.588735 2.990612 O 1 2 Volumes that can be produced: High Medium Dry hole 725,000 550,000 14 15 Volumes that can be processed: Tarih Summary CDE H . 1 ser Exploration, Inc is considering an investment in a project that is expected to have a five-year life. The investment would require the Company to drill a well at ac lion. Digger's hurdle rate is 20 percent. expected outcomes as a result of the drilling are: h volume: 50% probability could produce up to 725,000M MBtus each year for five years edium volume: 30% probability could produce up to 550,000M MBtus each year for five years y hole: 20% probabilty the well is sucessful, the Company would have to make a decision as to whether to build a small or large processing plant. A large processing plant would cost $1,000,000 to anstruct and could process up to 710,000 MMBtus each year for five years. A small processing plant would cost $500,000 to construct and could process up to 525,000 MMB ear for five years. The amount of gas that can be sold is also dependent on the favorability of the market. If the well proves to be good, the Company could sell up to 710,000 MMBtus each yea ve years whereas a poor market will limit the Company's sales to an estimated 450,000 MMBtus each year for five years. The probabilities of the market type are as follows High volume (Good Market): 75% Medium volume (Poor Market): 25% Finally, the price received is also dependent on the favorability of the market. The Company believes it will receive $2.75 per MMBtu in a good market but only $2.40 per MME in a poor market. Required: 1. Calculate the NPVs for Options 1,2,3. & 4. 2. Construct a decision tree, in good form, that lists the 10 possible outcomes. 3. What is your recommendation e. should the Company drill the well? If so, what size of a processing plant do you recommend? What is the expected value of your recommendation? Amount Probability Period PVOA of $1 Item Capital costs Drill well Build large processing plant Build small processing plant 20.00% 3,000,000 1,000,000 500,000 Finandal Factors Table FV of $1 FVOA of $ 1 1.000000 1.200000 1.000000 1.440000 2.200000 1.728000 3.6-40000 2.073600 5:368000 2.488320 7.441600 PV of $ 1 1.000000 0.833333 0.694444 0.578704 0.482253 0.401878 0.833333 1.527778 2.106481 2.588735 2.990612 O 1 2 Volumes that can be produced: High Medium Dry hole 725,000 550,000 14 15 Volumes that can be processed: Tarih Summary
