Question
There is a piece of land and you have information that it has underground natural gas reserves. However, you do not know how large the
There is a piece of land and you have information that it has underground natural gas reserves. However, you do not know how large the reserves are. You are offered to purchase the land (including the right to extract and sell the natural gas) for $20 million. If purchased, you can send you geological exploration team in order to investigate the size of the gas reserves which will cost $2 million upfront and take one year. After the investigation, you will know whether the reserves are large or small. Your geological advisor estimates that the chances for a large gas field are 40%. If the reserves are large, building production facilities will cost $10 million. If the reserves are small, building production facilities will only costs only $2 million. Building the production facilities will take 1 year before the first gas can be extracted. Assume that the large gas field will provide forever sales of $6 million every year at an annual cost of $1 million. The small gas field will provide sales forever of $2.5 million every year at an annual cost of $500,000. If you decide not to exploit the natural gas, you can sell the land immediately for other use for $17 million. Assume a cost of capital of 10%
Compute the value of the project.
Step by Step Solution
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