Time Value of Money
Please see the attached file.
The Chinese government is conducting an auction for a joint project involving oil exploration. Because of a desire for U.S. dollars, they require the winning bidder to make an up-front, one-time payment for the rights to join the project and supervise the work. The Chinese government will use the proceeds to cover all of the expenses during the life of the project. The winning bidder will receive a single payment at the end of the ten-year life of the project. This payment, based on the amount of the winning bid, will pay either simple interest of 15 percent annually or 10 percent annually compounded quarterly. Blue Mesa Oil’s bid team has to help evaluate its $47 million bid. First, find out the future value, on a per dollar basis, of each of the two interest payment options. Next, compute the future value of the $47 million bid using each option, and determine which is bigger.
Blue Mesa Oil Company is considering two projects. The As Is Project involves drilling for oil using existing technology. Given the estimated reserves, this project is expected to produce $15.6 million at the end of year 3. Due to the relatively low level of risk involved, management’s required rate of return is 12.5 percent.
The Bedrock project involves using new technology to drill for oil from a field located beneath bedrock. Given the higher risk involved, this project must provide a rate of return of 14.6 percent. If the new technique works, the project is expected to produce $12.4 million in only 2 years. Compute the present value of each project using annual compounding, and report on the relative values and the difference between the two.