Pilipinas-Shell, Inc. is contemplating whether to drill for oil source on a tract of land that the company had purchased 10 years ago. The investment required for this project is PhP450.0 million. If the project is pursued, it is expected to bring in cash flows of PhP215.0 million annually for the next four years. With the limited market information available to support the financial forecast, the firm is considering of waiting 2 years before implementing the project until more reliable geology information as well as oil prices be made available. If the firm opt to wait for 2 years, the project will cost PhP600.0 million then cash flows will be expected to continue for 4 years after the initial investment. In addition, if the firm waits for 2 years, there is only 95% chance that expected cash flows will be at PhP220.0 million annually for 4 years. Contrary, there is the 5% chance that the cash flows will be at PhP120.0 million annually for 4 years. The firm used the 11% WACC for this project. What is the expected NPV should the firm proceed with the drilling project today? Will it be more advantageous for the firm to wait 2 years before implementing the project? Discuss. Determine the value of the option. What disadvantages might arise from delaying the timing of the project? Discuss.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

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Pilipinas-Shell, Inc. is contemplating whether to drill for oil source on a tract of land that the company had purchased 10 years ago. The investment required for this project is PhP450.0 million. If the project is pursued, it is expected to bring in cash flows of PhP215.0 million annually for the next four years. With the limited market information available to support the financial forecast, the firm is considering of waiting 2 years before implementing the project until more reliable geology information as well as oil prices be made available. If the firm opt to wait for 2 years, the project will cost PhP600.0 million then cash flows will be expected to continue for 4 years after the initial investment. In addition, if the firm waits for 2 years, there is only 95% chance that expected cash flows will be at PhP220.0 million annually for 4 years. Contrary, there is the 5% chance that the cash flows will be at PhP120.0 million annually for 4 years. The firm used the 11% WACC for this project.

What is the expected NPV should the firm proceed with the drilling project today?
Will it be more advantageous for the firm to wait 2 years before implementing the project? Discuss.
Determine the value of the option.
What disadvantages might arise from delaying the timing of the project? Discuss.

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