8. (15 points) Petroleum Inc. (PI) controls off-shore oil leases. It is considering the construction of a deep-sea oil rig at a cost of $500 million. The price of oil is $100/bbl. and extraction costs are $50/bbl. PI expects costs to remain constant. The rig will produce an estimated 1,200,000 bbl. per year forever. The risk-free rate is 10 percent per year, which is also the cost of capital. (Ignore taxes). Suppose that oil prices are uncertain and are equally likely to be $120/bbl. or $80/bbl. next year. Suppose that PI has the option to postpone the project by one year. Calculate the value of the real option to postpone the project for one year.

4. (10%) For her estate in Connecticut, Marsha Jones purchased a used Mercedes horse transporter. The price was $35,000.00. The goal is to reduce the cost of renting a horse transporter. For $200 per day plus $1 per mile, Marsha had been hiring a transporter every other week. The majority of the journeys are between 80 and 100 miles long. Joe Laminitis, the driver, often receives a $40 gratuity from Marsha. She will just need to pay for maintenance and diesel fuel with the new transporter, which costs around $0.45 per mile. The annual insurance premium for Marsha's transporter is $1,200. When Marsha's horse Spike is ready to retire in eight years, the transporter will most likely be worth $15,000 (in real terms). Is the transporter a positive-NPV investment? Assume a nominal discount rate of 9% and a 3% forecasted inflation rate. Marsha's transporter is a personal outlay, not a business or financial investment, so taxes can be ignored.

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