Suppose the oil price is uncertain and can be $60/bbl or $30/bbl next year with equal probability, then expected NPV of the project if postponed by one year is: (approximately)
A) +50 million
B) -25 million
C) +59 million
D) None of the above

Question

Quizplus · Accepted Answer

If the project is postponed by 1 year, the expected cash inflows in both scenarios will be the same as given in the project NPV calculation. However, the value of these cash inflows will decrease due to the time value of money, i.e. discounting at the required rate of return.

Thus, the expected NPV of the project with postponement can be calculated as follows:

Expected NPV with $60/bbl = (150/1.1) - 100 = +36.36 million
Expected NPV with $30/bbl = (50/1.1) - 100 = -54.54 million

Expected NPV = (0.5 x +36.36 million) + (0.5 x -54.54 million) = -9.09 million

Therefore, postponing the project by one year will decrease the expected NPV by $9.09 million, making the answer B.

Suppose the Oil Price Is Uncertain and Can Be $60/bbl