Question

Your firm’s geologists have discovered a small oil field in New York’s Westchester County. The field is forecasted to produce a cash flow of C1 $2 million in the first year. You estimate that you could earn an expected return of r 12% from investing in stocks with a similar degree of risk to your oil field. Therefore, 12% is the opportunity cost of capital. What is the present value? The answer, of course, depends on what happens to the cash flows after the first year. Calculate present value for the following cases: a. The cash flows are forecasted to continue for 20 years only, with no expected growth or decline during that period b. The cash flows are forecasted to continue for 20 years only, increasing by 3% per year because of inflation c. Evaluate the cashflows in a and b and explain which one you will choose and why

i need question c i already know the results of a and b ( 14.93 millions ,18.06 millions) , thank you in advance

Answer 1

Based on the given data, pls find below the Net Present Value of the Cash Flows based on option (a) with no change in the Cash flows and option (b) with 3% increase in Cash Flows due to inflation factor;

(c) Inflation is the economic indicator and is influential factor incase of many financial applications; Considering the expected inconsistency on the forecasted cash flows, it is more appropriate to consider the inflation % as part of cash flow projections rather than just considering the real cash flows; This helps in establishing the change in the value of money over the period of life of the Project. In this case, hence cash flows with inflation factor (b) shall be considered and also, the NPV of the same is positive and higher than the option (a).