Reference no: EM131045382

1. An oil company has some land that is reported to possibly contain oil. The company classifies such land into four categories by the total number of barrels that are expected to be obtained from the well, i.e. a 500,000 - barrel well, 200,000 - barrel well, 50,000 - barrel well, and a dry well. The company is faced with deciding whether to drill for oil, to unconditionally lease the land or to conditionally lease the land at a rate depending upon oil strike. The cost of drilling the well is $100,000; if it is a producing well and the cost of drilling is $75,000 if it is a dry well. For producing well, the profit per barrel of oil is $1.50, after deduction of processing and all other costs except drilling costs.

Under the unconditional lease agreement, the company receives $45,000 for the land whereas for the conditional lease agreement the company receives 50 cents for each barrel of oil extracted if it is a 500,000 or 200,000 barrel oil strike and nothing if otherwise.

Which alternative should be selected based on the following criteria?

a) LaPlace

b) Maximax

c) Maximin

d) Hurwicz with α = 0.4

e) MinMax with regret

2. For problem 1, the probability for striking a 500,000 - barrel well is 0.1, probability for striking a 200,000 - barrel well is 0.15, probability for striking a50,000 - barrel well is 0.25, and probability for a dry well is 0.5.

a) Using the expected value criteria, which alternative should be selected?

b) Using the most probable outcome, which alternative should be selected?

c) What is the value of perfect information?

3. There is a project being considered that has an initial cost of $5,000. The first year profit is $500 and profits are expected to increase by 50% every year after that. Project costs are expected to be $1,000 for the first two years and then decrease by 5% every year after that. The project life is expected to be 10 years and the company MARR is 10%.

a) What is the payback period for this project?

b) What is the rate of return for this project?

c) What is the present worth of this project?

d) The project must be shortened to 6 years. Under this constraint, is the project worth doing and why?

4. There are seven projects to consider that have the following net yearly cash flows.

	0	1	2	3	4	5	6
P1	$      (5,000)	$            575	$        489	$        710	$     1,020	$    2,015	$    3,485
P2	$      (3,000)	$            300	$        700	$     1,502	$        985	$      920	$       -
P3	$      (6,000)	$            560	$        980	$     1,400	$     1,208	$      985	$   1,328
P4	$      (1,000)	$            452	$        560	$        687	$          52	$       -	$       -
P5	$      (9,000)	$            700	$     1,500	$     1,580	$     1,621	$    1,735	$    1,863
P6	$    (10,000)	$         2,560	$     2,200	$     2,100	$     3,200	$    4,532	$       -
P7	$    (12,000)	$         3,200	$     3,100	$     6,350	$     5,892	$       -	$       -

The MARR for this company is 10%.

a) If there were no restrictions, which projects would you recommend?

b) If the payback period must be no greater than 4 years, which projects would you recommend?

c) If your initial budget was $19,000, which projects would you recommend?

d) If the MARR was increased to 20%, which projects would you recommend?

5. You are looking to purchase a new vehicle for $25,789. This vehicle gets 22 mpg and you average driving 14,000 miles per year. You expect that gasoline will average $2.10 per gallon for the first year and will increase 15% per year but it will never get above $5 per gallon because of government controls. Maintenance is included for the first two years but after that you think that maintenance will cost $1,000 and increase by 10% per year after that. The vehicle will lose 30% of its value the first year but the salvage value will only decrease by 10% per year after that. For an interest rate of 5%, what is the economic life of the vehicle?