Problem 11. Your company invests $100,000 in operating equipment that returns $40,000 annually for 3 years. The interest rate is 5 percent. The equipment has a salvage value of $50,000. The investment’s discounted net cash flow ($ thousand) is closest to: (A) $142 (B) $152 (C) $42 (D) $52.
Solved in the Guidebook for Net Present Value (NPV). This problem, however, asks for discounted net cash flow (NCF). So just ignore the initial investment of $100M: answer (B).
This problem is too easy but I include it to help practice reading questions carefully. Note that the NPV answer is included as an option, and since that's a more common calculation it's the kind of mistake can happen to anyone. So always check work.
This should equal D. 52 as stated in the PEH chapter 16 Petroleum Economics page 775 16.2.15 Net Cash Flow. Net cash flow is the amount of money that flows into or out of the
ReplyDeletetreasury during any one period. It is equal to the net operating income (either before or after
income taxes) less the investments.
Investments are included in net cash flow calculation however they are ignored in a net income calculation
Unknown, you give a great example of why so many "know" they passed, and are so perplexed they have failed. Read the blog post about Voucher on this issue.
DeleteOn this problem, it's been a while since I looked at it and wouldn't be surprised if there was an error somewhere, but I think you may have confused NCF (Net Cash Flow, which is what the PEH uses) and DNCF (Discounted Net Cash Flow) which is what this problem uses. NCF doesn't include investment; DNCF does. Check out the Guidebook explanation on this. Also, be very careful using the PEH as a "plug-n-chug" text, as you can see from this example...it will be easy to trip folk up with just a few definitional changes if you know they will be using a certain text. Remember, it doesn't have to be in the PEH, just in any SPE book. Tons of options for test writers. If the problem looks easy, it's probably something you may missing.
If you include the investment I come up with 52,122.
Delete-100,000 + (40,000)/1.05 + (40,000)/1.05^2 + (40,000+50,000)/(1.05^3)
Both the PEH and Bing's binder consider net cash flow to be net operating income less investments. I don't understand why saying it's discounted or not would change whether you include the investment cost. Not trying to be disrespectful but just trying to get clarification so I get it correctly on exam day.
The SPE reference guide also defines net cash flow, discounted cash flow, and NPV on pages 180 and 181 and 182. Based on the NPV calculation it appears that net cash flow includes both opex and capex in the calculation.
No worries! Thanks for the Q.
DeleteThe SPE RG never defines "DNCF". It's not really a defined term like NCF is. So I would have to read it like discounted NET CASH FLOW. This was my attempt to force the tester go "work out" what it all means. It can't mean NCF, since this term is clearly defined as just the net flow of cash. So the best way to read it would be "discounting" the net cash flow using the initial investment, keeping the NCF definition intact. By doing this, you will have looked over all the terms and come to your own estimate. This is how I experienced taking the exam; very little plug-n-chug but lots of definitional confusion. But I agree this one seems a little far afield and I'll look it over and make some changes for clarity. It's been so long I can't remember the details :-).