An oil producer discovers an oil supply in Texas that can be pumped for a profit of $50 per barrel now, $60 per barrel in three years, $80 per barrel in five years, or $90 a barrel in seven years. The current market rate of interest is 3 percent. When should the oil producer extract the oil to obtain the most profit per barrel in present value terms?

Question

Quizplus · Accepted Answer

The present value of future profits is calculated by discounting future profits at the current interest rate. The present value of $90 in seven years at a 3% interest rate is higher than the present value of profits at other times, making it the most profitable option.

An Oil Producer Discovers an Oil Supply in Texas That