Question

Problem 2 (25 points) Suppose that an oil well is expected to produce 100,000 barrels (BBL) of oil during its first year of production. However, its subsequent production (or yield) is expected to decrease by 12% over the previous year's production for each year of production over the 7-year project. The oil well has proven reserves to satisfy the project requirements. The price of oil is expected to start at $120 per barrel during the first year and increase 8.5% over the previous year's price. The outsourced cost of operation is a fixed $500K per year for the life of the project. The well was purchased at the beginning of the first year at a bargain price of $1OM. Determine the PRESENT WORTH based on the cash flows for the 7-year project at an tnterest 12% compounded annually. rate of A. B Assume that the business plan calls for the. safe of the project at the end of the thin (entrepreneur's "exit strategy"). Determine the PW of the project at the anticipated time based on the remaining cash flow stream. (This is the upper limit of value from the perspective.)

Answer 1

a: The Present worth will be

-53412802.78

By this the oil well is not a viable project.

WORKINGS

Annual Production and prices as follows

Year	Production	Price
0
1	100000	120
2	88000	130.2
3	77440	141.267
4	68147.2	153.2747
5	59969.54	166.303
6	52773.19	180.4388
7	46440.41	195.7761

Net cash flows are

Year	Initial cost	Revenues	Costs	Net Cash flows
0	-100000000			-100000000
1		12000000	-500000	11500000
2		11457600	-500000	10957600
3		10939716	-500000	10439716.48
4		10445241	-500000	9945241.295
5		9973116	-500000	9473116.389
6		9522332	-500000	9022331.528
7		9091922	-500000	8591922.143

We have used excel NPV function for computation as per image

2: Present worth at end of year 3 =

$28,313,829.33

We have used excel NPV function for computation as per image

Book1- Excel X AutoSave ( Off Sign in Tell me what you want to do File Formulas Review View Help Share Home Insert Draw Page Layout Data A A Calibri Wrap Text Number 11 Conditional Format as Formatting BIU Cell Insert Delete Format Sort & Find & Paste A Merge & Center . $% Table Styles Filter Select Clipboard Alignment Number Styles Cell: Editing Font =NPV ( 12 % , 14 : 1 10)+13 f 12 A F G B D F H J K 1 Year Production Price Initial cost Revenues Costs Net Cash flows 2 -SUM (F3 :H3) SUM(F4:H4) -SUM(F5:H5) 3 C 100000000 C4*D4 4 1 100000 120 -500000 -D4*108.5 % -C4*88 % C5* D5 5 500000 -C5*88% =D5*108.5% C6* D6 -500000 -SUM(F6: H6) =SUM(F7:H7) SUM(F8:H8) -SUM (F9:H9) =SUM(F10:H10) 6 =D6 108.5 % =D7 108.5% =D8 108.5 % -C6*88% C7*D7 7 4 -500000 C7*88% C8*D8 8 5 -500000 EC9*D9 C8*88% 9 6 -500000 - C9* 88 % -D9 * 108.5 % -C10* D10 -500000 10 7 11 NPV(12 % ,14 :110)+13 NPV(12 % , 17 : 110) 12 NPV 13 NPV at T3 14. 15 16 17 Sheet2 Sheet3 Sheet1 +1009% Ready x P ENG 5:06 AM