An oil company is considering drilling in the Gulf at a current cost of $300,000 with an expected profit of $500,000 in three years. The current market rate is 10 percent. Should the company make the investment?

Question

Quizplus · Accepted Answer

To determine whether the investment is worthwhile, we need to compare the present value of the expected profit to the present value of the cost. We can use the formula:

PV = FV / (1 + r)^n

where PV is the present value, FV is the future value, r is the discount rate, and n is the number of periods.

In this case, the cost is $300,000, which is the present value. The expected profit in three years is $500,000, but we need to discount it back to its present value using the market rate of 10 percent. Using the formula:

PV = $500,000 / (1 + 0.10)^3 = $383,542.16

Since the present value of the profit ($383,542.16) is greater than the present value of the cost ($300,000), it is worthwhile for the oil company to make the investment. Therefore, the answer is C.

An Oil Company Is Considering Drilling in the Gulf at a Current