Question

Wildcat Drilling is an oil and gas exploration company that currently operating two active oil fields with a market value of $200 million dollars each. Unfortunately, Wildcat Drilling has $500 million in debt coming due at the end of the year.

A large oil company has offered Wildcat drilling a highly speculative, but potentially very valuable, oil and gas lease in exchange for one of their active oil fields. If Wildcat accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion, a 15% that Wildcat will discover a productive oil field that would be worth $600 million, and a 75% chance that Wildcat will not discover oil at all.

a) What is the overall expected payoff to Wildcat from the speculative oil lease deal?

b) What is the expected payoff to debt holders with the speculative oil lease deal?

c) What is the expected payoff to equity holders with the speculative oil lease deal? Will they vote for the deal?

Answer 1

Solution:

a.

Expected payoff = (0.1) ($1,200) + (0.15) ($600) + (0.75) ($200)

Expected payoff = $360 million

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b.

Expected payoff = (0.1) ($500) + (0.15) ($500) + (0.75) ($200)

Expected payoff = $275 million

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c.

Expected payoff = (0.1) ($1,200 - $500) + (0.15) ($600 - $500) + (0.75) ($200 - $200)

Expected payoff = $85 million