Question

You are the international operations manager for ExxonMobil and you are considering investing in an offshore oil rig. The development can be done instantly at a cost of $10,000,000. The oil company can extract 30,000 barrels of oil per year forever at a cost of $50 per barrel (the initial extraction can be done immediately after making the investment). The current price of a barrel of oil is $100. Next year, the price of a barrel may increase to $150 or it may decrease to $50 with equal probability. After that, the price will remain constant. The interest rate is 10%. Should ExxonMobil invest today, wait one year until the uncertainty is resolved (if so, under what conditions should ExxonMobil invest?), or never?

Answer 1

According to the Analysis, The Manager should not Invest in the current year due to Uncertainity. In the next year, If price of the barrel is dropped down to 50$, then the NPV will be

and if the price of the barrel goes up to $150, then the NPV should be,

so he should invest if Price of the barrel will be 150$