The Beta for a producing well is 0.7. The market risk premium is 7.5%, and the risk-free-rate is 3.6%. For simplicity assume there are no taxes and make further assumptions as necessary. a. What is the correct discount rate for cash flows from the developed wells? b. What is the NPV of the cash flows from the well if you are guaranteed to strike oil (i.e., ignoring the risk of a dry hole)? Construct a pro forma to show your answer. c. The oil company executive proposes to add 20 percentage points to the discount rate to offset the risk of a dry hole. He calls this a "fudge factor." Calculate the NPV of the well with this adjusted discount rate. d. What do you say the NPV of the well is? Is it your answer from b or your answer from c, or something else? Why? If it is something else, please calculate it here.

The Beta for a producing well is 0.7. The market risk premium is 7.5%, and the risk-free-rate is 3.6%. For simplicity assume there are no taxes and make further assumptions as necessary. a. What is the correct discount rate for cash flows from the developed wells? b. What is the NPV of the cash flows from the well if you are guaranteed to strike oil (i.e., ignoring the risk of a dry hole)? Construct a pro forma to show your answer. c. The oil company executive proposes to add 20 percentage points to the discount rate to offset the risk of a dry hole. He calls this a "fudge factor." Calculate the NPV of the well with this adjusted discount rate. d. What do you say the NPV of the well is? Is it your answer from b or your answer from c, or something else? Why? If it is something else, please calculate it here.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter9: Capital Budgeting And Cash Flow Analysis

Section: Chapter Questions

Problem 13P

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