A Middle Eastern country has an oil reserve that it can extract for a profit of $60 a barrel today, $65 a barrel in two years, $70 a barrel in three years, and $75 in four years. The current market rate of interest is 7 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: $60 (no need to discount) - In two years: $65 / (1 + 0.07)^2 ≈ $56.76 - In three years: $70 / (1 + 0.07)^3 ≈ $56.99 - In four years: $75 / (1 + 0.07)^4 ≈ $57.31 Among these, $60 today has the highest present value, making it the most profitable option.

A Middle Eastern Country Has an Oil Reserve That It