Exxon-Mobil is planning to sell a number of producing oil wells. The wells are expected to produce 100,000 barrels of oil per year for 8 more years at a selling price of $28 per barrel for the next 2 years, increasing by $1 per barrel through year 8. How much should an independent refiner be willing to pay for the wells now, if the interest rate is 10% per year?

$15,297,732.26 or $16,098,076.98

Explanation:

An independent refiner will be willing to pay the discounted value of the total proceeds from oil sales from the oil wells.

The question is ambiguous regarding the rate of increase in the price of oil after year 2, so two solutions are provided for the increase.

Solution 1: oil price is $28 for years 1 and 2, then increases by $1 to $29 for years 3 to 8.

Inflow for years 1 and 2 = 28 * 100,000 = 2,800,000

Inflows for years 3 to 8 = 29 * 100,000 = 2,900,000

Therefore, the present value of all inflows with a discount rate of 10% =

= $15,297,732.26.

Solution 2: oil price is $28 for years 1 and 2, then increases by $1 every year from years 3 to 8.

Inflow for years 1 and 2 = 28 * 100,000 = 2,800,000

Inflows for years 3 = 29 * 100,000 = 2,900,000

Inflows for years 4 = 30 * 100,000 = 3,000,000

Inflows for years 5 = 31 * 100,000 = 3,100,000

Inflows for years 6 = 32 * 100,000 = 3,200,000

Inflows for years 7 = 33 * 100,000 = 3,300,000

Inflows for years 8 = 34 * 100,000 = 3,400,000

Therefore, the present value of all inflows with a discount rate of 10% =

= $16,098,076.98.