Question

Real Options: Quantitative problems Quantitative Problem 1 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 $4.21 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.105 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 $4.66 million. Moreover, if it waits two years, there is a 50% chance that the cash flows would be $2.208 million a year for four years, and there is a 50% chance that the cash flows will be $0.771 million a year for four years. Assume that all cash flows are discounted at a 8% WACC. If the company chooses to drill today, what is the project's net present value? Round your answer to five decimal places. million Quantitative Problem 2: 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 $4.51 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.255 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 $5.13 million. Moreover, if it waits two years, there is a 95% chance that the cash flows would be $2.365 million a year for four years, and there is a 5% chance that the cash flows will be $1.294 million a year for four years. Assume that all cash flows are discounted at a 7% WACC. What is the project's net present value in today's dollars, if the firm waits two years before deciding whether too drill? million (to 5 decimals) Quantitative Problem 3: 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 $4.8 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.4 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 $5.11 million. Moreover, if it waits two years, there is a 70% chance that the cash flows would be $2.455 million a year for four years, and there is a 30% chance that the cash flows will be $1.3 million a year for four years. Assume that all cash flows are discounted at a 10% WACC. Will the company delay the project and wait until they have more information? -Select-

Answer 1

(1) If the company decides to drill today, the project cost = $ 4.21 million, WACC = 8 %, Annual Positive Cash Flows = $ 2.105 million, Tenure = 4 years

Present Value of Annual Cash Flows = 2.105 x (1/0.08) x [1-{1/(1.08)^(4)} = $ 6.97203 million

Project NPV = 6.97203 - 4.21 = $ 2.76203 million ~ $ 2.76 million

NOTE: Please raise separate queries for solutions to the remaining unrelated questions as one query is restricted to the solution of only one complete question with up to four sub-parts.