An oil producer discovers an oil supply in Texas that can be pumped for a profit of $60 per barrel now, $65 per barrel in three years, $70 per barrel in five years, or $75 a barrel in seven years. The current market rate of interest is 5 percent. When should the oil producer extract the oil to obtain the most profit per barrel in present value terms?

Question

Quizplus · Accepted Answer

To determine the most profit per barrel in present value terms, we calculate the present value (PV) of the profits for each option using the formula PV = FV / (1 + r)^n, where FV is the future value (profit per barrel), r is the interest rate (5% or 0.05), and n is the number of years. Calculating for each:- Today: $60 (no need to discount, it's already in present value terms).- In three years: $65 / (1 + 0.05)^3 ≈ $56.23.- In five years: $70 / (1 + 0.05)^5 ≈ $54.83.- In seven years: $75 / (1 + 0.05)^7 ≈ $53.45.The highest present value is $60, which is obtained by extracting the oil today.

An Oil Producer Discovers an Oil Supply in Texas That