Problem 9-25 Fudge factorsAn oil company executive is considering investing $10.1 million in one or both of two wells: well 1is expected to produce oil worth $3.01 million a year for 10 years; well 2 is expected to produce$2.01 million for 15 years. These are real (inflation-adjusted) cash flows.The beta for producing wells is 0.91. The market risk premium is 9%, the nominal risk-free interestrate is 7%, and expected inflation is 3%.The two wells are intended to develop a previously discovered oil field. Unfortunately there is still a21% chance of a dry hole in each case. A dry hole means zero cash flows and a complete loss ofthe $10.1 million investment.Ignore taxes and make further assumptions as necessary.a. What is the correct real discount rate for cash flows from developed wells? (Do not roundintermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)Real discount rateb. The oil company executive proposes to add 20 percentage points to the real discount rate tooffset the risk of a dry hole. Calculate the NPV of each well with this adjusted discount rate.(Negative answers should be indicated by a minus sign. Do not round intermediatecalculations. Enter your answers in dollars not in millions and round your answers to thenearest whole dollar amount.)NPVWell 1Well 2c. Are the NPVS calculated in Part B the correct NPVS? If they are correct, re-enter the NPVS fromyour answers in Part B for both wells. If they are incorrect, re-calculate the NPVS to the correctvalues for both wells. (Do not round intermediate calculations. Enter your answers in dollarsnot in millions and round your answers to the nearest whole dollar amount.) Are the NPVS in Part B correct?Well 1 NPVWell 2 NPV

NPV It is the present cash inflows less the present values of cash out flows. If the cash inflows…

An oil company executive is considering investing $10.1 million in one or both of two wells: well 1 is expected to produce oil worth $3.01 million a year for 10 years; well 2 is expected to produce $2.01 million for 15 years. These are real (inflation-adjusted) cash flows. The beta for producing wells is 0.91. The market risk premium is 9%, the nominal risk-free interest rate is 7%, and expected inflation is 3%. The two wells are intended to develop a previously discovered oil field. Unfortunately there is still a 21% chance of a dry hole in each case. A dry hole means zero cash flows and a complete loss of the $10.1 million investment. Ignore taxes and make further assumptions as necessary. a. What is the correct real discount rate for cash flows from developed wells? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

An oil company executive is considering investing $10.1 million in one or both of two wells: well 1 is expected to produce oil worth $3.01 million a year for 10 years; well 2 is expected to produce $2.01 million for 15 years. These are real (inflation-adjusted) cash flows. The beta for producing wells is 0.91. The market risk premium is 9%, the nominal risk-free interest rate is 7%, and expected inflation is 3%. The two wells are intended to develop a previously discovered oil field. Unfortunately there is still a 21% chance of a dry hole in each case. A dry hole means zero cash flows and a complete loss of the $10.1 million investment. Ignore taxes and make further assumptions as necessary. a. What is the correct real discount rate for cash flows from developed wells? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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