NEWSWIRE - July 30, 2001

Topic: Value Maximization, Capital Budgeting and Real Options

Source: "Oil Giants Struggle to Spend Profits Amid Shortages of Exploration Sites," by Christopher Cooper and Thaddeus Herrick, Wall Street Journal, Monday, July 30, 2001, page A1

Synopsis of Article: Royal Dutch/Shell Group is sitting on more than $11 billion in cash and has generated profits of approximately $1.5 million per hour in its extremely successful first quarter. This leads to an interesting question, what should Royal Dutch/Shell do with all of its cash? The article discusses the decision by Royal Dutch/Shell and several other large oil companies to invest in a public works project to harvest water, electricity, and petrochemicals in Saudi Arabia. The project is outside the core business of the oil companies and appears to have optimistic returns projections. The article provides an opportunity to discuss free cash flow, shareholder value maximization, agency issues, and real options.

Questions:

1. What options does Royal Dutch/Shell have for spending its cash?
2. Why would managers at Royal Dutch/Shell and the other oil companies invest it a project that may not earn the cost of capital?
3. What are real options, and how might they relate to the value of this project?