The Bush Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project will cost $450 million today. Bush estimates that once drilled, the oil will generate positive cash flows of $215 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, it recognizes that if it waits 2 years, it will have more information about the local geology as well as the price of oil. Bush estimates that if it waits 2 years, the project will cost $600 million, and cash flows will continue for 4 years after the initial investment is made. Moreover, if it waits 2 years, there is a 95% chance that the cash flows will be $220 million a year for 4 years, and there is a 5% chance that the cash flows will be $120 million a year for 4 years. Assume that all cash flows are discounted at 11%. 1. If the company chooses to drill today, what is the project's expected net present value? 2. Would it make sense to wait 2 years before deciding whether to drill? Explain.
Question
The Bush Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project will cost $450 million today. Bush estimates that once drilled, the oil will generate positive cash flows of $215 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow
1. If the company chooses to drill today, what is the project's expected
2. Would it make sense to wait 2 years before deciding whether to drill? Explain.
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 1 images
