Shell is evaluating whether to construct oil well in Lethbridge, Alberta. Constructing the oil well will cost $ 14 million now. It would take 1 year to construct the well. The following will be the output from the oil well once it is constructed.
First year: 60,000 barrels.
Second year: 70,000 barrels
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Third year: 80,000 barrels
Fourth year: 100,000 barrels.
Fifth year: No oil production but shell must decommission oil well and it expects to pay around $ 1 million as a decommissioning cost.
The current price of crude oil per barrel is $ 50/ barrel. The oil price is expected to grow at 2% per year thereafter. If the discounting rate is 10%, would you undertake the project. What other non-financial considerations you would take into effect when you make this decision.
[ Hint: year 0 you would have cash inflow of $ 14 million; year 2 no activities; year 3 would be 60,000 barrels; year 4 would be 70,000 barrels and so on. Remember to increase the cash savings]