An oil company is offered a lease of a group of oil wells on which the primaryreserves are close to exhaustion. The major condition of the purchase is that the oilcompany must agree to undertake a water-flood project at the end of five years tomake possible secondary recovery. No immediate payment by the oil company is required. The relevant cash flows have been estimated as follows:
| Year | |||||
| 0 | 1-4 | 5 | 6-20 | Discounted-cash-flow rate of return | Net present worth at 10% |
| 0 | $50 ,000 | -$650,000 | $100,000 | ? | $227,000 |
Should the lease-and-flood arrangement be accepted? How should this proposal bepresented to the company board of directors who understand and make it a policy toevaluate by discounted-cash-flow rate of return?
