You inherited an oil well that will pay you $30,000 per year for 25 years, with

Question

You inherited an oil well that will pay you $30,000 per year for 25 years, with the first payment being made today.  If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it?

a.            $399,032.79                             b.            $359,489.00                             c.            $294,780.98                             d.            $269,616.75                             e.            $348,704.33
You inherited an oil well that will pay you $30,000 per year for 25 years, with the first payment being made today.  If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it?

a.            $399,032.79                             b.            $359,489.00                             c.            $294,780.98                             d.            $269,616.75                             e.            $348,704.33
You inherited an oil well that will pay you $30,000 per year for 25 years, with the first payment being made today.  If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it?

a.            $399,032.79                             b.            $359,489.00                             c.            $294,780.98                             d.            $269,616.75                             e.            $348,704.33
$399,032.79 $359,489.00 $294,780.98 $269,616.75 $348,704.33 a.            $399,032.79                             b.            $359,489.00                             c.            $294,780.98                             d.            $269,616.75                             e.            $348,704.33

Explanation / Answer

Using 7.5% as the discount rate, the answer is $359,489. You get to this by creating an excel formula:

1) Create 25 columns and number them 1-25

2) In the next column, put 30,000 in all cells

3) You need to discount each year. Since you're getting $30K today, there is no discount in the first year. For year 2 and beyond, you need to use the following formula: =30000/(1+0.075)^n -- where "n" is the number of years from after the first payment.

This is how it will look when you're done:

in year 1 (today): 30000

in year 2: 30000/(1+0.075)^1

in year 3: 30000/(1+0.075)^2

...in year 25: 30000/(1+0.075)^24

Sum up all of these cells and you get $359,489. The big caveat here is that 7.5% is the discount rate. I'm not clear on whether this is the rate of return or discount rate based on your question -- but hopefully this helps.

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