Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

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.

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 $13 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $6.11 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 years it will have more information about the local geology and about the price of oil. Karns estimates that if it waits 2 years then the project would cost $14.5 million. Moreover, if it waits 2 years, then there is a 90% chance that the net cash flows would be $6.89 million a year for 4 years and a 10% chance that they would be $3.9 million a year for 4 years. Assume all cash flows are discounted at 10%.

  1. If the company chooses to drill today, what is the project's net present value? Negative value, if any, should be indicated by a minus sign. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to two decimal places. $ million
  2. Using decision-tree analysis, does it make sense to wait 2 years before deciding whether to drill? -Select-Yes, it makes sense to wait two years to drill.No, it makes sense to drill today.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Numerical Techniques In Finance

Authors: Simon Benninga

1st Edition

0262022869, 978-0262022866

More Books

Students also viewed these Finance questions