Discount Rates for Oil Exploration

You are a senior manager at an automobile company. In an effort to offer a full menu of auto and gas products, your firm is considering an oil exploration project. The CEO has selected the manager of the company’s truck division to oversee the project, and has asked you to evaluate whether the company should proceed with the exploration or not.

To help you evaluate the project, your associate gives you the following information:

Company Equity Beta D/(D+E)

General American Oil                          1.81                                                             0.03

Lousiana Land & Exploration 1.29 0.12

Mesa Petroleum                                  2.36 0.37

Murphy Oil                                           1.60 0.27

Natomas Oil                                        1.84 0.41       

Oceanic Exploration                           1.53 0.23

Superior Oil                                          1.35 0.16

a) Should you also ask the associate for similar information on car manufacturers? On truck manufacturers? On automobile companies? On your firm in particular? Why or why not?

b) Based on the information you have available, calculate an appropriate discount rate assuming that risk free rate is 4% and market return is 7%. Assume that the debt of the companies your associate looked at is risk free. Assume that the oil exploration project is 100% equity financed.