An Oil Company Controls Two Oil Fields

question 4

Essay

An oil company controls two oil fields. Field 1 can produce up to 45 million barrels of oil per day, and Field 2 can produce up to 55 million barrels of oil per day. At Field 1, it costs $3 to extract and refine a barrel of oil; at Field 2, the cost is $2. The company sells oil to two countries: France and Japan. The shipping costs per barrel are shown below. Each day, France is willing to buy up to 45 million barrels (at $6 per barrel), and Japan is willing to buy up to 35 million barrels (at $6.50 per barrel). Determine how to maximize the company's profit.

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Definitions:

Option to Abandon

A clause in an investment contract granting the investor the right to withdraw from the project under certain conditions, typically to minimize losses.

NPV

Net Present Value; a calculation that compares the value of money now to the value of that money in the future, taking inflation and returns into account.

Static DCF Analysis

A method of valuing a project, company, or asset using the concepts of the time value of money where all cash flows are assumed to occur at fixed points in time.

Option to Expand

The option to expand is a strategic flexibility available to companies, allowing them to increase their investment in a project based on future market conditions or performance indicators.