Texas Wildcatters Inc

question 1

Multiple Choice

Texas Wildcatters Inc. (TWI) is in the business of finding and developing oil properties, and then selling the successful ones to major oil refining companies. TWI is now considering a new potential field, and its geologists have developed the following data, in thousands of dollars.
T = 0. A $400 feasibility study would be conducted at t = 0. The results of this study would determine if the company should commence drilling operations or make no further investment and abandon the project.
T = 1. If the feasibility study indicates good potential, the firm would spend $1,000 at t = 1 to drill exploratory wells. The best estimate is that there is an 80% probability that the exploratory wells would indicate good potential and thus that further work would be done, and a 20% probability that the outlook would look bad and the project would be abandoned.
T = 2. If the exploratory wells test positive, TWI would go ahead and spend $10,000 to obtain an accurate estimate of the amount of oil in the field at t = 2. The best estimate now is that there is a 60% probability that the results would be very good and a 40% probability that results would be poor and the field would be abandoned.
T = 3. If the full drilling program is carried out, there is a 50% probability of finding a lot of oil and receiving a $25,000 cash inflow at t = 3, and a 50% probability of finding less oil and then only receiving a $10,000 inflow.
Since the project is considered to be quite risky, a 20% cost of capital is used. What is the project's expected NPV, in thousands of dollars?

• A) $336.15
• B) $373.50
• C) $415.00
• D) $461.11
• E) $507.22

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Definitions:

Real Value

The value of an object, factoring in the effects of inflation on purchasing power.

CPI (Consumer Price Index)

A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care, used to estimate the cost of living.

Nominal Price

The price of a good or service without adjusting for the effects of inflation or deflation, representing its cost in current currency terms.

Economic Analysis

The systematic approach to determining the optimum use of scarce resources, involving comparison of two or more alternatives in achieving a specific objective under the given assumptions and constraints.