fm13 3 - Expected NPV = .1(-1.674) + .9(3.564) = 3.040 If...

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Answers and Solutions: 13 - 3 13-2 a. 0 1 2 3 4 ├─────┼─────┼─────┼─────┤ -8 4 4 4 4 NPV = $4.6795 million. b. Wait 2 years: PV @ 0 1 2 3 4 5 6 Yr. 2 | | | | | | | 10% Prob. 0 0 -9 2.2 2.2 2.2 2.2 $6.974 | | | | | | | 90% Prob. 0 0 -9 4.2 4.2 4.2 4.2 $13.313 Low CF scenario: NPV = (-9 + 6.974)/(1.1) 2 = -$1.674 High CF scenario: NPV = (-9 + 13.313)/(1.1) 2 = $3.564
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Unformatted text preview: Expected NPV = .1(-1.674) + .9(3.564) = 3.040 If the cash flows are only $2.2 million, the NPV of the project is negative and, thus, would not be undertaken. The value of the option of waiting two years is evaluated as 0.10($0) + 0.90($3.564) = $3.208 million. Since the NPV of waiting two years is less than going ahead and proceeding with the project today, it makes sense to drill today. 10% r = 10%...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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