Exhibit 14.1 Drilling Experts, Inc. (DEI) finds and develops oil properties and then sells the successful ones to major oil refining companies. DEI is now considering a new potential field, and its geologists have developed the following data, in thousands of dollars.
t=0 A $ 400 feasibility study would be conducted at t=0 . The results of this study would determine if the company should commence drilling operations or make no further investment and abandon the project.
t=1 If the feasibility study indicates good potential, the firm would spend $ 1,000 at t=1 to drill exploratory wells. The best estimate is that there is an 80 % probability that the exploratory wells would indicate good potential and thus that further work would be done, and a 20 % probability that the outlook would look bad and the project would be abandoned.
t=2 If the exploratory wells test positive, DEI would go ahead and spend $ 10,000 to obtain an accurate estimate of the amount of oil in the field at t=2 . The best estimate now is that there is a 60 % probability that the results would be very good and a 40 % probability that results would be poor and the field would be abandoned.
t=3 If the full drilling program is carried out, there is a 50 % probability of finding a lot of oil and receiving a $ 25,000 cash inflow at t=3 , and a 50 % probability of finding less oil and then only receiving a $ 10,000 inflow.
-Refer to Exhibit 14.1.Calculate the project's coefficient of variation.(Hint: Use the expected NPV.)
