A company is considering extracting natural gas from one of its properties. The initial extraction cost is $8 million, and all of the gas will be extracted in two years. The profits from selling the natural gas will be $6 million in year 1 and $5 million in year 2. What is the net present value of this investment at 12%?

Question

Quizplus · Accepted Answer

The net present value formula for this investment is:

NPV = -Initial Cost + (Profit Year 1 / (1+r)^1) + (Profit Year 2 / (1+r)^2)

where r is the discount rate (12% in this case).

Substituting the values, we get:

NPV = -8,000,000 + (6,000,000 / 1.12^1) + (5,000,000 / 1.12^2)
NPV = -8,000,000 + 5,357,143 + 4,242,969
NPV = $1,600,112

Therefore, the net present value of the investment is $1,600,112. This means that the company should go ahead with the investment as it is positive. The option B is the best choice.

A Company Is Considering Extracting Natural Gas from One of Its