An oil company just spent $100,000 to do an analysis and determined that there is oil beneath Antarctica. To extract the oil, the company would need to invest in a new rig today. The cost of the rig is $200,000 and is to be fully depreciated over 20 years using the straight-line depreciation method. The rig will be need to be placed on a penguin nesting site, and the current penguins occupying the site would need to be evicted and a new site built for them. The cost of maintaining the new nesting site will be $10,000 per year.

The new rig will produce 1,000 barrels of oil per year, which will be priced at $100 each. The cost to extract the oil is $20 per barrel

At the end of 2 years, you expect that oil production will cease and you will be able to sell the rig for $700,000.

It is estimated that the firm needs to hold net working capital equal to 10% of total sales and that it will need to be injected today if the rig is purchased. The NWC balance will be withdrawn at the end of the project.

The firm is in the 30% tax bracket and the opportunity cost of capital is 10%.

Build a table of cash flows over the life of the project and use it to answer the following questions.

a) Are there any Opportunity Costs?

b) What are the EBIT, Depreciation, EBITDA and the Unlevered Net Income?

c) What is the amount of the depreciation tax shield?

d) What are the Free Cash Flows for the new rig?

e) Should you invest in the rig? Briefly explain.