Real Options: Quantitative problems Part 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 $4.7 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.35 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 $5.23 million. Moreover, if it waits two years, there is a 85% chance that the cash flows would be $2.436 million a year for four years, and there is a 15% chance that the cash flows will be $1.819 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 Part 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 $4.57 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.285 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 $5.05 million. Moreover, if it waits two years, there is a 85% chance that the cash flows would be $2.421 million a year for four years, and there is a 15% chance that the cash flows will be $1.33 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 to drill? $ million (to 5 decimals)

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
icon
Related questions
Question

Real Options: Quantitative problems

Part 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 $4.7 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.35 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 $5.23 million. Moreover, if it waits two years, there is a 85% chance that the cash flows would be $2.436 million a year for four years, and there is a 15% chance that the cash flows will be $1.819 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

Part 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 $4.57 million today. The firm estimates that once drilled, the oil will generate positive cash flows of $2.285 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 $5.05 million. Moreover, if it waits two years, there is a 85% chance that the cash flows would be $2.421 million a year for four years, and there is a 15% chance that the cash flows will be $1.33 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 to drill?
$ million (to 5 decimals)

Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 3 steps

Blurred answer
Knowledge Booster
Cash Flow Statement Analysis
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education