Consolidated Oilfields plc is interested in exploring for oil near the west coast of Australia. The Australian government is prepared to grant an exploration licence to the company for a five-year period for a fee of 300,000 p.a. The option to acquire the rights must be taken immediately, otherwise another oil company will be granted the rights. However, Consolidated Oilfields is not in a position to commence operations immediately, and exploration of the oilfield will not start until the beginning of the second year. In order to carry out the exploration work, the company will require equipment costing 10,400,000, which will be made by a specialist engineering company. Half of the equipment cost will be payable immediately and half will be paid when the equipment has been built and tested to the satisfaction of Consolidated Oilfields. It is estimated that the second instalment will be paid at the end of the first year. The company commissioned a geological survey of the area and the results suggest that the oilfield will produce relatively small amounts of high-quality crude oil. The survey cost 250,000 and is now due for payment. The assistant to the project accountant has produced the following projected profit and loss accounts (income statements) for the project for Years 25 when the oilfield is operational.

Year
		2		3		4
Sales		7400		8300		9800		5800
Less expenses
Wages and salaries	550		580		620		520
Materials and consumables	340		360		410		370
License fee	600		300		300		300
Overheads	220		220		220		220
depreciation	2100		2100		2100		2100
survey cost written off	250		-		-		-
interest charges	650		650		650		650
		4710		4210		4300		4160
profit		2690		4090		5500		1640

The following additional information is available: 1 The licence fee charge appearing in the accounts in Year 2 includes a write-off for all the annual fee payable in Year 1. The licence fee is paid to the Australian government at the end of each year. 2 The overheads contain an annual charge of 120,000, which represents an apportionment of head office costs. This is based on a standard calculation to ensure that all projects bear a fair share of the central administrative costs of the business. The remainder of the overheads relate directly to the project. 3 The survey costs written off relate to the geological survey already undertaken and due for payment immediately. 4 The new equipment costing 10,400,000 will be sold at the end of the licence period for 2,000,000. 5 The project will require a specialised cutting tool for a brief period at the end of Year 2, which is currently being used by the company on another project. The manager of the other project has estimated that he will have to hire machinery at a cost of 150,000 for the period the cutting tool is on loan. 6 The project will require an investment of 650,000 working capital from the end of the first year to the end of the licence period. The company has a cost of capital of 10 per cent. Ignore taxation.