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%
$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?
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