Price taking over time help?!
Question: Price taking over time help?
Current and expected future prices of a barrel of oil are now ￡8.5
1 years time ￡11.0
2 years time ￡13.0
3 years time ￡14.5
4 years time ￡15.5
5 years time ￡16.0
The current and expected rate of interest is 10%. A well contains 20,000 barrels of oil which cost ￡5 a barrel to extract whenever this is done. To maximise profit the well owner should.
A. Extract all the oil now.
B. Extract all the oil in three years time.
C. Extract all the oil in four years time.
D. Extract the oil evenly over the next five years.
I don't really understand what I'm meant to do with the interest rate? The answer is C by the way. Could someone explain step by step how I do this? Thank you in advance :)
1 years time ￡11.0
2 years time ￡13.0
3 years time ￡14.5
4 years time ￡15.5
5 years time ￡16.0
The current and expected rate of interest is 10%. A well contains 20,000 barrels of oil which cost ￡5 a barrel to extract whenever this is done. To maximise profit the well owner should.
A. Extract all the oil now.
B. Extract all the oil in three years time.
C. Extract all the oil in four years time.
D. Extract the oil evenly over the next five years.
I don't really understand what I'm meant to do with the interest rate? The answer is C by the way. Could someone explain step by step how I do this? Thank you in advance :)
Answers:
use Excel if you can.
compute discount factors
year 0:1.0
year 1: 1.1*1.0=1.10
year 2: 1.1*1.1=1.21
year 3: 1.1*1.21=...
subtract 5 from each price.
divide result by discount factor for matching year. That's present value of selling oil in a given year
sell in year which gives you highest present value