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You are considering buying a field that contains 393 barrels of oil that can be extracted. If you buy the field, you can extract the oil and sell it in one year from today; the cost of drilling and extracting the oil will be $16,899 when you do it in one year. Nothing happens after time 1. In other words, the only cash flow from owning the field occurs in one year from today and is given below:
Time
0
1
Cash flows
-(Purchase price of field)
If you drill: Proceeds from selling the 393 barrels of oil minus the $16,899 cost of extraction If you do not drill: $0
You expect the price of oil in one year to be $49.25 per barrel, and your discount rate is 19%.
Part A. How much are you willing to pay for the field? Assume that you are going to drill in one year regardless of the price of oil. That is, ignore real options
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