Question

Oil Inc. is drilling a series of new wells in the Rockport oil field. About 20% of the new wells are expected to be dry holes. Even if a new well strikes oil, there is uncertainty about the amount of oil produced: 40% of new wells, which strike oil, produce only 1,000,000 barrels per year; 60% produce 5,000,000 barrels per year. Producing wells typically produce oil for 10 years. The price of oil is $60 per barrel. Oil Inc.'s normal cost of capital is 10%. However, a geologist proposes to discount the cash flows of the new wells at a 20% to offset the risk of dry holes. Calculate the value of the Rockport oil field.

Answer 1