Suppose that an oil well is expected to produce 100,000 barrels of oil during its first year in production. However, subsequent annual production is expected to decrease by 10% relative to each previous year’s production. It is estimated currently that this oil well has a “proven” reserve of one million barrels, and the cost to produce this oil is $20 per barrel. We can assume that all of the oil that is produced is sold immediately.
a) If the price of oil is assumed to be $60 per barrel for the foreseeable future, what is the present worth of the anticipated revenues over the next seven years using an interest rate of 12% compounded annually? (Hint: Revenues = Price times Quantity)
b) If the price of oil is assumed to be $60 per barrel for the foreseeable future, what is the present worth of the anticipated profits over the next seven years using an interest rate of 12% compounded annually? (Hint: Here, you can adopt the simple definition that Profits = Revenues minus Costs.)