Morrison Oil and Gas Company’s (from Problem 11-5) chief financial analyst is Samuel ( Sam) Crawford. Sam completed his analysis, suggesting that the investment is indeed a good one for the company, and presented it to the firm’s executive committee, which consists of the firm’s CEO, CFO, and COO. The CFO thought Sam’s analysis was on target, but the COO and CEO were concerned about the fact that the hedging strategy would not work for the investment. In fact, they wondered why hedging the investment is such a good idea. Sam explained that the project is a good one because it allows them to perfectly hedge the investment cash flows using one-year call options on natural gas. These call options, which have a $ 13.90-per-MCF strike price, are selling for $ 1.86 per MCF. Show how selling call options on 50 MCF of gas today and undertaking the investment provides Morrison with a hedged (i. e., risk-free) investment.
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