Petroleum Inc.(PI)controls offshore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects prices and costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10% per year,which is also the cost of capital.(Ignore taxes).Calculate the NPV to invest today.
A)+100,000,000
B)+80,000,000
C)+60,000,000
D)+40,000,000Easiest to do computations in $M.

Question

Quizplus · Accepted Answer

The NPV is calculated as the present value of perpetual cash flows minus the initial investment. The annual cash flow is (100 - 50) * 1,200,000 = $60 million. The present value of these cash flows is $60 million / 0.10 = $600 million. The NPV is $600 million - $500 million = $100 million.