Question

Florida Seaside Oil Exploration Company is deciding whether to drill for oil off the northeast coast of Florida. The company estimates that the project would cost $4.99 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.495 million a year at the end of each of the next four years. While the company is fairly confident about its cash flow forecast, it recognizes that if it waits two years, it would have more information about the local geology as well as the price of oil. Florida Seaside estimates that if it waits two years, the project would cost $5.48 million. Moreover, if it waits two years, there is a 75% chance that the cash flows would be $2.582 million a year for four years, and there is a 25% chance that the cash flows will be $1.333 million a year for four years. Assume that all cash flows are discounted at a 12% WACC.

What is the project’s net present value in today’s dollars, if the firm waits two years before deciding whether to drill?
$ million (to 5 decimals)

Answer 1

	Answer:
	If Flosidaseaside Oil explaration company waits two Years before deciding whether to Dril, the NPV shall be Caculated using discounted rate of 12%
	Statement Showing Showing Expected Cash Flows
				Amount in $
	Particulars	Amount	Probability	Estimated Cash Flows
	Cash Flows	2.582	75%	1.9365
	Cash Flows	1.3333	25%	0.33333
	Total			2.26983
	Statement Showing Net Present Value of the Project	Amount in $
	Year	Particulars	Amount	Discount factor @12%	Present Value
	2	Project Cost	-5.48	0.7972	-4.36866
	3-6	Cash Flows	2.26983	2.4214	5.49615
	NPV				1.12750