Question

Royal Queen Petroleum has the following data for its Bayou Field: Property cost (acquisition cost)....... $ 60,000 Drilling cost (one well)................... 280,000 Estimated selling cost per bbl..................80 Estimated lifting cost per bbl...................26 State severance tax..................................5% Royalty interest...................................12.5% The company is considering two drilling plans which are estimated to have the following production: Well A: 600 bbl per month. Completion cost, $500,000. Well B: 1,000 bbl per month. Completion cost, 800,000.

Required: a. Determine the number of months needed for payout on each plan.

b. If the company depends on the payback method for its investment decision, which plan will be more preferred?

Answer 1

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Royal Queen Petroleum	Amount $
Particulars	Well A	Well B
Property cost	60,000.00	60,000.00
Drilling cost	280,000.00	280,000.00
Completion cost	500,000.00	800,000.00
Total cash outflow	840,000.00	1,140,000.00	A
Selling cost per bbl	80.00	80.00	B
Estimated lifting cost per bbl	(26.00)	(26.00)	C
State severance tax @ 5%	(4.00)	(4.00)	D
Royalty interest @ 12.5%	(10.00)	(10.00)	E
Net income per bbl	40.00	40.00	F=B+C+D+E
Estimated production per month	600.00	1,000.00	G
Net income per month	24,000.00	40,000.00	H=F*G
Payback Period (months)	35.00	28.50	I=A/H
Plan B will be more preferred as its payback period is less.