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 one year and $5 million in two years. What is the net present value of this investment at 12%?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the investment, we discount the future cash flows back to their present value and subtract the initial investment. Using a discount rate of 12%, the present value (PV) of the profits is calculated as follows:Year 1: PV = $6 million / (1 + 0.12)^1 = $5.357 millionYear 2: PV = $5 million / (1 + 0.12)^2 = $3.986 millionAdding these together gives a total present value of future cash flows of $9.343 million. Subtracting the initial investment of $8 million gives an NPV of $1.343 million.

A Company Is Considering Extracting Natural Gas from One of Its