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 $3.5 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 $3.8 million a year for 4 years, and there is a 15% chance that the cash flows will be $1.8 million a year for 4 years. Assume that all cash flows are discounted at 10%.
a.) 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. $ 3.0945 million
b.) 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 No, because the NPV of waiting two years is less than going ahead and proceeding with the project today.
c.) 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
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