A Middle Eastern country has an oil reserve that it can extract for a profit of $50 a barrel today, $55 a barrel in two years, $60 a barrel in three years, and $65 in four years. The current market rate of interest is 10 percent. When should this country tap into its oil reserve 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, r is the interest rate, and n is the number of years. Calculating for each option: - Today: $50 (no need to discount as it's already in present terms) - In two years: $55 / (1 + 0.10)^2 = $45.45 - In three years: $60 / (1 + 0.10)^3 = $45.13 - In four years: $65 / (1 + 0.10)^4 = $44.96 The highest present value is $50 for extracting today, making it the most profitable option in present value terms.

A Middle Eastern Country Has an Oil Reserve That It