The Karns Oil Company is deciding whether to drill for oil on a tract of land the company owns. The company estimates the project would cost $6 million today. There is a 75% chance that the net cash flows would be $3 million a year for 4 years and a 25% chance that they would be $1.5 million a year for 4 years. WACC = 8%

a. )What is the E(NPV) and CV of the project as is?

b.) Now suppose that if Karns Oil Company implements the project, there will exist an opportunity to rerun it, thus there exists a growth option. The firm will replicate the original project at the end of its life, only if it adds value. Assume no changes to the cost of the project and the cash flows associated with the project. What is the E(NPV) and CV of the project with the growth option?

c.) Calculate the value of the growth option using Black-Scholes option pricing model. Also, show the total value for the project with the option to grow (i.e., add the value of the project without the option and what you found using Black-Scholes) Assume the risk-free rate is 5%, N(d1) = 0.9225, and N(d2) = 0.8389.

d.) Now suppose the project can be delayed, so there exists an investment timing option. Karns estimates that if it waits 2 years, it will have more information about the demand for oil and oil prices. The firm will invest in the project in 2 years only if it adds value. Assume all cash flows are discounted at 8%. What is the E(NPV) and CV of the project with the timing option?

e.) Calculate the value of the option to delay the project using Black-Scholes option pricing model. Assume the risk-free rate is 5%, N(d1) = 0.9023, and N(d2) = 0.8346.