Question

jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large of land in one year. The current market price of crude oil is $60 per barrel, and the land is believed to contains 495,000 barrels of oils. If found, the oil would cost $70 million to extract. Treasury bill that mature in one year yield a continuously compounded interest rate of 4 percent, and the standard deviation of the returns on the price of crude oil is 50 percent. Use the black-scholes model to calculate the maximum bid that the company should be willing to make at the auction.

Answer 1

We need to solve this as a call option and hence apply the Black Scholes Model:

Presented below is a snapshot from my model:

Current stock price = Price x volume = 60 x 495,000 =  29,700,000

Strike Price = 70 million = 70,000,000

Hence, the maximum bid that the company should be willing to make at the auction = Value of the call option = $  467,394.63