PART C. (20 marks) You are considering purchasing the rights to operate an older oil refinery in Coode Island (Australia) for one year beginning today. The price of refined oil is currently $100a barrel since many refineries in North America are not currently able to operate due to being damaged by hurricane Harvey. Prices over the next year for refined oil will either rise by 25%, with 50% probability, or fall 10% with 50% probability. The current price of unrefined oil is currently S50. Unrefined oil prices will either double or stay the same, with equal probability, depending on what happens in the Middle East. Assume that because weather and political events are currently the main drivers of these oil price changes, that the movement in the prices of refined and unrefined oil over the next year will be uncorrelated. To be refurbished in order to meet current environmental standards, the refinery requires an investment of $150 million today. If this cost is paid, the refinery can be operated for one year. Operating for one year enables you to refine 2 million barrels "today" and '2 million barrels one year from today. The only input you need is unrefined oil, which you will buy on the spot market today and one year from today if and when you choose to operate the refinery. There are no other costs besides the initial refurbishment costs. The proper discount rate for all uncertain cash flows in this question is 5%. (a) What are the four possible (joint) outcomes for refined and unrefined oil prices one year from now? What are the present values of each of these cash flows today?(6) (b) What is the value today of the right to operate the refinery for one year if you have to make all operating decisions at the time you buy the rights to the refinery?(4) (c) What is the maximum you would be willing to pay for the right to operate the refinery for one year if you can make your operating decisions at each date once you learn the spot prices of refined and unrefined oil? (Note: Spot prices are just the prevailing prices at that time.) (d) Would you be willing to pay more or less for the right to operate the refinery if the Middle East stabilized and the spot price for unrefined oil was certain to be $75 next year? Assume you will not know what the spot price of refined oil will be PART C. (20 marks) You are considering purchasing the rights to operate an older oil refinery in Coode Island (Australia) for one year beginning today. The price of refined oil is currently $100a barrel since many refineries in North America are not currently able to operate due to being damaged by hurricane Harvey. Prices over the next year for refined oil will either rise by 25%, with 50% probability, or fall 10% with 50% probability. The current price of unrefined oil is currently S50. Unrefined oil prices will either double or stay the same, with equal probability, depending on what happens in the Middle East. Assume that because weather and political events are currently the main drivers of these oil price changes, that the movement in the prices of refined and unrefined oil over the next year will be uncorrelated. To be refurbished in order to meet current environmental standards, the refinery requires an investment of $150 million today. If this cost is paid, the refinery can be operated for one year. Operating for one year enables you to refine 2 million barrels "today" and '2 million barrels one year from today. The only input you need is unrefined oil, which you will buy on the spot market today and one year from today if and when you choose to operate the refinery. There are no other costs besides the initial refurbishment costs. The proper discount rate for all uncertain cash flows in this question is 5%. (a) What are the four possible (joint) outcomes for refined and unrefined oil prices one year from now? What are the present values of each of these cash flows today?(6) (b) What is the value today of the right to operate the refinery for one year if you have to make all operating decisions at the time you buy the rights to the refinery?(4) (c) What is the maximum you would be willing to pay for the right to operate the refinery for one year if you can make your operating decisions at each date once you learn the spot prices of refined and unrefined oil? (Note: Spot prices are just the prevailing prices at that time.) (d) Would you be willing to pay more or less for the right to operate the refinery if the Middle East stabilized and the spot price for unrefined oil was certain to be $75 next year? Assume you will not know what the spot price of refined oil will be
