Reference no: EM131188192
Consider the following drilling investment:
The lease costs $200,000 and has to be paid for all cases at time zero.
Drilling will cost $500,000 at the end of year 1 for all cases at time zero.
Here are possible cases:
Failure: There is 75% probability that well is a dry hole. In this case no money is made and abandonment cost of 100,000 dollars has to be paid at the end of year 2 and project ends.
Success: Drilling is successful and well is a producer. In this case:
With 40% probability producer well yields the income of $600,000 per year for the next 9 years (from year 2 to year 10).
With 60% probability producer well yields the income of $400,000 per year for the next 14 years (from year 2 to year 15).
Calculate the Expected NPV for minimum ROR 8% and conclude if this is a good investment.
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