12-1: Suppose you own the option to extract 1,000 barrels of oil from public lan
ID: 2698431 • Letter: 1
Question
12-1: Suppose you own the option to extract 1,000 barrels of oil from public land over the next two years. You are deciding whether to extract the oil immediately, allowing you to sell the oil for $20 per barrel, or to wait until next year to extract the oil and sell it then for an uncertain price. The extraction costs are $17 per barrel. The forward price is $20, and you know that oil prices next year will be either $15 per barrel or $25 per barrel, depending on demand conditions. Are you better off extracting the oil today or waiting one year? Explain how your answer might be different if prices next year are either more or less certain but have the same mean.
12-5: The Central and Southeast Power Company or Mobile, Alabama, is considering a new power plant that will allow it to switch between gas and oil. The company has a contract to provide it with gas for $8 that is sufficient to produce one unit of electric power. (The numbers are standardized to one unit for ease of computation.) However, the plant can also be run using fuel oil. The price of fuel oil is uncertain, and the firm's analysts believe that the uncertain future price can be characterized as a triangular distribution with a minimum value of $2, a most likely value of $7, and a maximum value of $12. Next year, the pland is expected to produce one standard unit of electrical power that can be sold for $10.
a. What is the expected cash flow from the power plant for next year, if the cost of fuel is set equal to the minimum of the expected costs of gas and oil? (Hint: there are no taxes, and the only expenses that the plant incurs are for fuel.)
b. Construct a simple Crystal Ball simulation model for the plant's cash flow using a triangular distribution for the cost of fuel oil and selecting the minimum-cost source of fuel to run the plant. What is the expected cash flow from the power plant based on your simulation?
c. If the cost of capital for the plant is 10% and the cash flows for the plant are expected to be constant forever, what is the value of the plant?
Explanation / Answer
uppose you want to extract oil from public land in over two years it may be or may not be proffitable , because as you know the actuall present price is $17 per barrel , if you wait for more one year the price may be increase or decrease between $15 - $25 . If you extract after an year the market price may be decrease at that time , so that without taking any risk if u agree with my answer it is good option to extract the oil immediately without waiting.
12-5 Ans:
a.
The expected cash flow from the power plant for next year will be above $10 if they use gas, it may be minimal value i.e; $5 if they use fuel.
b.
the expected cash flow from the power plant based on simulation will be high than the present cost.
c.
the value of the plant will be $10 if the cost remains constant forever
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