Question

In: Finance

The Karns Oil Company is deciding whether to drill for oil on a tract of land...

The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local geology and about the price of oil. Karns estimates that if it waits 2 years then the project would cost $9 million. Moreover, if it waits 2 years, then there is a 90% chance that the net cash flows would be $4.2 million a year for 4 years and a 10% chance that they would be $2.2 million a year for 4 years. Assume all cash flows are discounted at 10%.

1.Use the Black-Scholes model to estimate the value of the option. Assume the variance of the project's rate of return is 0.111 and that the risk-free rate is 8%. Do not round intermediate calculations. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answer to three decimal places. $ ____ million

Solutions

Expert Solution

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

RISK FREE RATE = 8%


Related Solutions

The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $13 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $6.5 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $8 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $12 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $5.52 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project would cost $8 million today. Karns estimates that once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $12 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $6 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Karns Oil Company is deciding whether to drill for oil on a tract of land...
The Karns Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates the project would cost $10 million today. Karns estimates that, once drilled, the oil will generate positive net cash flows of $4.6 million a year at the end of each of the next 4 years. Although the company is fairly confident about its cash flow forecast, in 2 years it will have more information about the local...
The Bush Oil Company is deciding whether to drill for oil on a tract of land...
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 $6 million today. Bush estimates that once drilled, the oil will generate positive cash flows of $3.9 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...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT