Question
The Engler Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the
The Engler Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project will cost $8 million today. Engler estimates that once drilled, the oil will generate positive cash flows of $3.9 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, it recognizes that if it waits 2 years, it will have more information about the local geology as well as the price of oil. Engler estimates that if it waits 2 years, the project will cost $10 million, and cash flows will continue for 4 years after the initial investment is made. Moreover, if it waits 2 years, there is a 85% chance that the cash flows will be $4.2 million a year for 4 years, and there is a 15% chance that the cash flows will be $2.2 million a year for 4 years. Assume that all cash flows are discounted at 10%.
- If the company chooses to drill today, what is the projects expected net present value? Enter your answer in millions. For example, an answer of $1.2345 million should be entered as 1.2345, not 1,234,500. Do not round intermediate calculations. Round your answer to four decimal places. $ million
- Would it make sense to wait 2 years before deciding whether to drill? Enter your answer in millions. For example, an answer of $1.2345 million should be entered as 1.2345, not 1,234,500. Do not round intermediate calculations. Round your answer to four decimal places. NPV of waiting: $ million -Select-YesNoItem 3 , because the NPV of waiting two years is -Select-lessgreaterItem 4 than going ahead and proceeding with the project today.
- What is the value of the investment timing option? Enter your answer in millions. For example, an answer of $1.2345 million should be entered as 1.2345, not 1,234,500. If an amount is zero, enter 0. Do not round intermediate calculations. Round your answer to four decimal places. $ million
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started