Corporate Finance You are an analyst in the Finance department at Drill company which drills wells to produceoil. The cost of drilling each well is $20,000,000, but, 40% of new wells will be “dry holes”; 60% wouldproduce oil. If a new well produces oil, the well will produce exactly 100,000 barrels at the end of eachyear for the next five years, AND Drill can sign a long-term contract with company XYZ where XYZ buysthe oil from Drill at a price of $90 per barrel. Company XYZ’s debt yields 7% annually. XYZ’s obligationto purchase the oil from Drill has the same seniority in the capital structure as XYZ’s debt. Drill’s Costof Equity is 14%, it’s cost of debt is 9%, and its WACC is 10%.You are asked to value this project. 1) To discount the Cash Flows, do you use Drill’s Cost ofEquity, Drill’s cost of debt, Drill’s WACC, XYZ’s debt yield, or some other number. Explain Why. 2) What is the NPV?
You are an analyst in the Finance department at Drill company which drills wells to produce
oil. The cost of drilling each well is $20,000,000, but, 40% of new wells will be “dry holes”; 60% would
produce oil. If a new well produces oil, the well will produce exactly 100,000 barrels at the end of each
year for the next five years, AND Drill can sign a long-term contract with company XYZ where XYZ buys
the oil from Drill at a price of $90 per barrel. Company XYZ’s debt yields 7% annually. XYZ’s obligation
to purchase the oil from Drill has the same seniority in the capital structure as XYZ’s debt. Drill’s Cost
of Equity is 14%, it’s cost of debt is 9%, and its WACC is 10%.
You are asked to value this project. 1) To discount the Cash Flows, do you use Drill’s Cost of
Equity, Drill’s cost of debt, Drill’s WACC, XYZ’s debt yield, or some other number. Explain Why. 2) What is the
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