Investment Timing Option: Decision$-$Tree Analysis

The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company

estimates the project would cost $$16$ million today. Karns estimates that, once drilled, the oil will generate positive net

cash flows of $$8$ million a year at the end of each of the next $4$ years. Although the company is fairly confident about

its cash flow forecast, in $2$ vears it will have more information about the local geology and about the price of oil. Karns

$90\%$ chance that the net cash flows would be $$8\mathrm{.}4$ million a year for $4$ years and a $10\%$ chance that they would be

$$4\mathrm{.}4$ million a year for $4$ years. Assume all cash flows are discounted at $11\%.$

a$.$ If the company chooses to drill today, what is the project's net present value? Do not round intermediate

calculations. Enter your answer in millions. For example, an answer of $$1\mathrm{.}23$ million should be entered as $1\mathrm{.}23,$ not

$1,230,000.$ Round your answer to two decimal places.

$

million

b$.$ Using decision$-$tree analysis, does it make sense to wait $2$ years before deciding whether to drill?