Question
Imagine that you are the CEO of an oil company. Your company owns the right to drill on an offshore tract of land, having won
Imagine that you are the CEO of an oil company. Your company owns the right to drill on an offshore tract of land, having won an auction and paid $2 million for those drilling rights. The expected return to drilling on this land was 17% (with conventional cash flows) at the time you placed the bid, and your required return at the time was 14%, so the project was expected to have a positive NPV. Since then, however, government policy has changed. Extra regulatory costs of drilling have lowered the expected return to 15% (not including the cost of the lease), while the added risk of drilling under an administration that disapproves of oil exploration and production has raised the required return to 16%. Based on the principles of capital budgeting from Chapters 9 and 8, which of the following are correct? Choose all that apply.
A.
Your decision should not be influenced by regulatory costs.
B.
You should not drill now, because the current NPV is negative.
C.
You should begin drilling now, because the expected return is still positive.
D.
You still have a valuable option the option to delay commitment and thus you should wait and perhaps drill later if the regulatory costs and risk go back down again.
E.
Your decision should not be influenced by the cost of purchasing the drilling rights, because that is a sunk cost.
F.
You should begin drilling now, because the expected return is still above the original required return of 14%.
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