Reference no: EM131901750

The Bush Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project will cost $8 million today. Bush estimates that once drilled, the oil will generate positive cash flows of $4 million per year at the end of each of the next four years. Although the company is confident about its cash flow forecast, it recognizes that if it waits two years, it will have more information about the local geology as well as the price of oil. Bush estimates that if the company waits 2 years, the project will cost $9 million and cash flows will continue for 4 years after the initial investment. Moreover, if the company waits for 2 years, there is a .90 probability that cash flows will equal $4.2 million each year for four years, and a .10 probability that cash flows will equal $2.2 million a year for 4 years. Assume that all cash flows are discounted at 10%. a. If the company drills today, what is the project’s expected NPV? b. Would it make sense to wait 2 years before deciding whether to drill? Support your response with computations. c. What is the value of option to delay?