Question
You are the international operations manager for ExxonMobil and you are considering investing in an offshore oil rig. The development can be done instantly at
You are the international operations manager for ExxonMobil and you are considering investing in an offshore oil rig. The development can be done instantly at a cost of $10,000,000. The oil company can extract 30,000 barrels of oil per year forever at a cost of $50 per barrel (the initial extraction can be done immediately after making the investment). The current price of a barrel of oil is $100. Next year, the price of a barrel may increase to $150 or it may decrease to $50 with equal probability. After that, the price will remain constant. The interest rate is 10%. Should ExxonMobil invest today, wait one year until the uncertainty is resolved (if so, under what conditions should ExxonMobil invest?), or never?
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