Question
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
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 $11 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $5.06 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 $13.5 million. Moreover, if it waits 2 years, then there is a 90% chance that the net cash flows would be $5.83 million a year for 4 years and a 10% chance that they would be $2.86 million a year for 4 years. Assume all cash flows are discounted at 11%.
If the company chooses to drill today, what is the project's net present value? A negative value should be entered with a negative sign. Enter your answer in millions.
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