Reference no: EM13970769
Drilling Experts, Inc. (DEI) finds and develops oil properties and then sells the successful ones to major oil refining companies. DEI is now considering a new potential field, and its geologists have developed the following data, in thousands of dollars.
t = 0. A $400 feasibility study would be conducted at t = 0. The results of this study would determine if the company should commence drilling operations or make no further investment and abandon the project.
t = 1. If the feasibility study indicates good potential, the firm would spend $1,000 at t = 1 to drill exploratory wells. The best estimate is that there is an 80% probability that the exploratory wells would indicate good potential and thus that further work would be done, and a 20% probability that the outlook would look bad and the project would be abandoned.
t = 2. If the exploratory wells test positive, DEI would go ahead and spend $10,000 to obtain an accurate estimate of the amount of oil in the field at t = 2. The best estimate now is that there is a 60% probability that the results would be very good and a 40% probability that results would be poor and the field would be abandoned.
t = 3. If the full drilling program is carried out, there is a 50% probability of finding a lot of oil and receiving a $25,000 cash inflow at t = 3, and a 50% probability of finding less oil and then only receiving a $10,000 inflow.
Refer to Exhibit 14.1. Since the project is considered to be quite risky, a 20% cost of capital is used. What is the project's expected NPV, in thousands of dollars?
A) $336.15
B) $373.50
C) $415.00
D) $461.11
E) $507.22
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