Problem 57. Two 20-year leases are considered for investment:
Type/Investment: Gas/$450M; Oil/$720M.
Type/Annual Revenues: Gas/$90M; Oil/$135M.
Type/Annual Expenses: Gas/$9M; Oil/$11.7M.
Type/Salvage value: Gas/$45M; Oil/$67M.
If the cost of unlimited capital is 15%, the statement most TRUE regarding NPV analysis is:
(A) The difference between the oil and gas leases NPV is between $0 and $5,000.
(B) ONLY the oil lease investment may be chosen.
(C) ONLY the gas lease investment may be chosen.
(D) NEITHER the oil or gas lease investment may be chosen.
Guidebook 10 ECN 1 and Petroleum Engineering Handbook I, Mian, PennWell (1983) can help on this problem. Once you know about NPV, the difficulty becomes apparent. Which is: 20 years is difficult to calculate by hand for the two scenarios. It can be done, but time is precious. Use PWF (present worth factor) for the salvage & SCAF (series compound amount factor) for the revenue:
-450M+(90M-9M)(SCAF)+45,000(PWF)
-450M+(90M-9M)(6.2593)+45,000(0.0611) = $59,753
-720M+(135M-11.7M)(6.2593)+67.5M(0.0611) = $55,896
UPDATE: It seems most don't have access to the tables so I'm going to show the calculations for SCAF for a number of years (n) at an interest rate (i) is:
SCAF = {[1 - (1 + i)^(-n)] / i} = (1 - 1.15^(-20)) = 6.2593.
And of course PWF is in the Guidebook:
PWF = (1 + i)^(-n) = (1.15^(-20) = 0.0611
Anon below points out the formula (arranged differently) is in HS1 P777. It's called the "Series CAF".
If we don't have Mian--just take a loss on this one? Or i guess leave it until the end and then come back and calculate?
ReplyDeleteNo; it says the cost of capital is "unlimited" so this is not a "mutually exclusive investment analysis". This makes B, C are likely false as well as D so I would just grab (A). If I had time at the end I would come back and try one or both MPV calcs (I know a few guys who are that fast on the calculator). Make sense?
DeleteWhat is P/A? How do you get that value?
ReplyDeletePresent value (PV) of annual sums, converted to their equiv value in preset value dollars is P/A. Or, the present value of an annuity. Here I used interest tables for the P/A factor. The following conditions are req: non-changing a) periodic payments, b) time intervals, c) interest rates, d) compounding times.
DeleteFor future yearly payments (F), for a number of years (n) at an interest rate (i), the NPV is:
ReplyDeleteNPV = F * {[1 - (1 + i)^(-n)] / i}
Keeping this formula handy may help if P/A table is not readily available.
Not sure this NPV equation can be used in this problem with speed like the P/A I show. If so, the solution should fit into a combox if you want to show the steps.
DeleteI did not have the P/A tables with direct values of P/A (sorry, I don't have the PEH reference). The formula for P/A for a number of years (n) at an interest rate (i) is:
DeleteP/A = {[1 - (1 + i)^(-n)] / i} = (1 - 1.15^(-20)) = 6.2593
From the guidebook, P/F = (1 + i)^(-n) = (1.15^(-20) = 0.0611
Then use as you have shown above. Possibly saving some time going to the PEH book if it is available. The formula arranged in a different way is in HS-1 p777.
I just wrote the formula in the GB in case there is a problem that involves annuities in the future (I am using a 2017 version of the GB).
Thank you anon, that's a good idea and I should include it since the PEH is a rare text these days. Btw my gmail is mdavidgo if you have any other suggestions for GB additions, that's a gem for everyone here.
DeleteHi David,
ReplyDeleteIt is claimed that the SPE petroleum certification exam consists of drilling, production and reservoir engineering. Can one assume that economics is part of the SPEC exam?
I've never taken the certification exam, so have no idea.
Delete