Louisiana Drilling and Exploration, Inc. (LD&E) has the funds necessary to complete one

of two risky oil and gas drilling projects.The first, Permian Basin 1, involves the

recovery of a well that was plugged and abandoned five years ago but that may now be

profitable, given improved recovery techniques.The second, Permian Basin 2, is a new

onshore exploratory well that appears to be especially promising.Based on a detailed

analysis by its technical staff, LD&E projects a ten-year life for each well with annual net

cash flows as follows:

Project

Probability (P)

Annual Cash Flow (CF)

Permian Basin 1

0.08

0.84

0.08

$500,000

1,000,000

1,500,000

Permian Basin 2

0.18

0.64

0.18

300,000

900,000

1,500,000

In the recovery-project valuation, LD&E uses 20% and 32% discount rate forPermian Basin 1 and Permian Basin 2, respectively. Both projects involve land acquisition, as well as surface preparation and subsurface drilling costs of $3 million each.

a).Calculate the expected value of annual cash flows for each project.

b).Calculate the NPV for each project.

c).Which project is preferred using the NPV criterion?