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Real Options

Petroleum Inc. is considering a $50 million investment in a deep-sea oil rig, with an initial NPV of $25 million based on current oil prices. If postponed by one year, the expected NPV considering uncertain future oil prices is approximately $35.4 million, leading to a value of the option to wait of $10.4 million. This option adds value by allowing the company to benefit from potential increases in oil prices, thus increasing the project's NPV.

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Анастасия Осипкина
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64 views1 page

Real Options

Petroleum Inc. is considering a $50 million investment in a deep-sea oil rig, with an initial NPV of $25 million based on current oil prices. If postponed by one year, the expected NPV considering uncertain future oil prices is approximately $35.4 million, leading to a value of the option to wait of $10.4 million. This option adds value by allowing the company to benefit from potential increases in oil prices, thus increasing the project's NPV.

Uploaded by

Анастасия Осипкина
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

Petroleum Inc. owns a lease to extract crude oil from sea.

It is considering the construction of a


deep-sea oil rig at a cost of $50 million (I 0) and is expected to remain constant. The price of oil P is
$40/bbl and the extraction costs are $25/bbl. The quantity of oil Q=300,000 bbl per year forever.
The risk-free rate is 6% per year and that is also the cost of capital (Ignore taxes). Answer
questions:

1) Calculate the NPV to invest today.


Answer:
( 40−25 )∗300,000
NPV today = - 50,000,000 + = -50,000,000 + 75,000,000 = +25,000,000 million
0.06

2) Suppose the oil price is uncertain and can be $50/bbl or $30/bbl next year (equal
possibility), then please expected NPV of the project if postponed by one year.
Answer:
a) Calculate NPV if the price would be 50$/bbl
( 50−25 )∗300,000
NPV (50$) = - 50,000,000 + = -50,000,000 + 125,000,000 = +75,000,000
0.06
million
b) Calculate NPV if the price would be 30$/bbl
( 30−25 )∗300,000
NPV (30$) = - 50,000,000 + = -50,000,000 + 25,000,000 = -75,000,000 million
0.06
As NPV < 0 (reject), NPV (30$) = 0
c) Calculate the expected NPV
0.5∗0+0.5∗75,000,000
Expected NPV = = 35,377,358.5$ = 35,4 million
1.06

3) Calculate the value of the option to wait for one year.


Answer:
Value of the option to wait for one year = NPV of the project if postponed by one year – NPV to
invest now
Value of the option = 35,4 – 25 = 10,4 million

4) How does this option to wait or postpone this project add value to this project?
A project with an option of wait or postpone adds value to the value of the project as this is in the
expectation of the increase in the value of the inflows in future which will lead in increasing NPV.
So, if the company invest today then the NPV is equal to 25$ mln, however if it postpones to extract
crude oil by one year, the NPV is equal to 35,4$ mln. Uncertainty of oil prices increases the value of
the deferral option and NPV by 10,4$ mln

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