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Well testing taking place before permanent well completion is referred to as drill stem testing. After...

Well testing taking place before permanent well completion is referred to as drill stem testing. After a testing well drilled, a oil company has found that a permanent well will generate cash flow for $30 million per year for the next 5 years. The testing well costs $25 million to drill and the permanent well costs $100 million. The company's cost of capital is 15%. Should the company go ahead to drill a permanent well

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Answer #1

Testing well is a sunk cost which will be incurred regardless of whether well become permanent or not.So, it will not be considered during our decision making.

as the NPV is positive it is recommended to invest in the project

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