Reference no: EM133665248
Problem: Oil exploitation company XYZ plans to exploit a large oil field that the management proudly considers imperishable, which will make the company a perpetual legacy. She requested a quote from two major drilling equipment manufacturers to decide what type of equipment to purchase. Manufacturer A offers equipment that costs $12 million and has a lifespan of 4 years. The equipment does not require any maintenance during its operation, but at the end of each year of use it requires repair costs of $6 million otherwise it will not be functional the following year. At the end of the fourth year, if the company carries out the annual repair, it will be able to sell it to a groundwater exploration company for $4M, otherwise it will have no value. Manufacturer B, for its part, offers more sophisticated equipment, which costs $16 million with a lifespan of 9 years and requiring maintenance costs whose value at the end of each year of use is $4 million. Its resale value is zero at the end of the ninth year. Manufacturers A and B charged fees of $17,000 and $19,000 respectively for the two estimates provided. They also demanded an exclusivity clause in the sense that if company XYZ opts for their equipment, it will always have to renew it with them, under the same conditions, throughout the entire oil exploitation project. Currently, the company is financed 75% by debt at a cost of 10% and 25% by equity at a cost of 30%. She also has a line of credit of 10 million dollars with her bank, at a rate of 8%. Now suppose that the managers of Company XYZ are convinced that the price of oil will move significantly towards the end of the ninth year of operation. However, they are not certain whether this variation will be upwards or downwards. On the one hand, several research projects into the exploitation of solar energy in maritime and air transport are underway. There would be a 50% chance that this research would be successful, which would result in a drop in the price of a barrel of oil to $15 per barrel. This drop will not affect the potential turnover for the first nine years, but if it subsequently turns out that the exploitation of the field is no longer profitable, the company retains the option of abandoning its project. On the other hand, if this research is unsuccessful, the scarcity of global oil will cause the price of a barrel to rise to $25. In this case, the company reserves the right to increase its annual production to 1.5 million barrels by adding a second drilling equipment. The manufacturer of this equipment specified in its initial quote that in this case, it will grant a 30% discount on the purchase price of the additional equipment necessary to increase production. If the company decides to increase its production, the unit variable cost of production will then increase to $20 per barrel. With this new information, what is the net present value of the mining project. Should the company undertake the project? If so, what will she have to do in nine years?