You are considering investing in an oil well in Azerbaijan. The well costs 40 million and generates

Question:

You are considering investing in an oil well in Azerbaijan. The well costs £40 million and generates end-of-year expected after-tax cash flow of £10 million per year in perpetuity. The appropriate risk-adjusted is 20 percent per year. There is a 20 percent chance that the Azerbaijan government will expropriate your asset immediately after you invest.
a. What is the value of the oil well in the absence of expropriation risk?
b. What is the expected loss in value from expropriation risk?
c. What is the value of the oil well in the presence of expropriation risk?
Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...