Petroleum Inc

Multiple Choice

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 (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore taxes) . Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year. If the project if postponed by one year, calculate the value of the option to wait for one year: (approximately)

A) +15,000,000
B) +40,000,000
C) +10,000,000
D) none of the above