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An oil company contemplates investing 100 million dollars per year (in constant dollars) for five...

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Accounting

An oil company contemplates investing 100 million dollars per year (in constant dollars) for five years in exploratory work to confirm the existence of new exploitable reserves. It will then face a potential delay until market conditions justify exploitation, which will require investing 200 million dollars for three years in production facilities, following which delivery of oil can start with a projected net revenue of 100 million dollars per year, essentially ad infinitum.

a. At a real discount rate of 5%/yr what is the longest delay tolerable between the start of exploitation and the start of oil delivery: i.e., how far in advance is it worth proving out reserves?

b. If the real discount rate were 10%/yr, what is the maximum time delay?

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