Question

Calculate the NPV for the following investment with 6 years life time assuming a discount rate of 20% per year:

The investor is a Non-integrated petroleum company
Total producible oil in the reserve is estimated to be 2,400,000 barrels
Production rate will be 400,000 barrels of oil per year from year 1 to year 6
Mineral rights acquisition cost for the property will be $1,600,000 at time zero
Intangible drilling cost (IDC) is expected to be $7,000,000 at time zero
Tangible equipment cost is $4,000,000 at time zero
Working capital of $1,500,000 also at time zero
Equipment depreciation will be based on MACRS 5-years life depreciation starting from year 1 to year 6 (use the rates in table A-1 for 5-years half-year convention)
The production selling price is assumed $50 per barrel which has 10% escalation each year beginning in year 2
Operating cost is $1,500,000 annually with escalation rate of 10% beginning in year 2
Income tax is 35%
Royalty is 15%

Note: for depletion cost calculation you can amortize the Mineral rights acquisition cost equally over 6 years. For this problem, you can assume that if the firm has negative income in a given year, then the income tax will also be negative. Thus, you should have a negative number for the income tax in Year 0.

Answer 1

INITIAL INVESTMENT:
Tangible equipment	$4,000,000
Mineral rights acquisition cost	$1,600,000
Intangible drilling cost	$7,000,000
Working capital	$1,500,000
	$14,100,000
Year	1	2	3	4	5	6
Production in barrels	400,000	400,000	400,000	400,000	400,000	400,000
Sales revenues @50 per barrel in yr 1 with escalation of 10% from Yr 2	$20,000,000	$22,000,000	$24,200,000	$26,620,000	$29,282,000	$32,210,200
Less: Expenses
Operating cost with escalation of 10% from yr 2	$1,500,000	$1,650,000	$1,815,000	$1,996,500	$2,196,150	$2,415,765
Royalty (15% on sales)	$3,000,000	$3,300,000	$3,630,000	$3,993,000	$4,392,300	$4,831,530
Depreciation rate (%)	20	32	19.2	11.52	11.52	5.76
Depreciation	$800,000	$1,280,000	$768,000	$460,800	$460,800	$230,400
Amortization of minerals rights
acquisition costs	$266,667	$266,667	$266,667	$266,667	$266,666	$266,666
Intangible drilling costs	$7,000,000	0	0	0	0	0
(elected as current business
expense)
Income before tax	$7,433,333	$15,503,333	$17,720,333	$19,903,033	$21,966,084	$24,465,839
Tax @ 35%	$2,601,667	$5,426,167	$6,202,117	$6,966,062	$7,688,129	$8,563,044
Income after tax	$4,831,666	$10,077,166	$11,518,216	$12,936,971	$14,277,955	$15,902,795
Add: Depreciation/Amortization	$5,898,333	$11,623,833	$12,552,883	$13,664,438	$15,005,421	$16,399,861
Annual Cash flows after tax	$10,730,000	$21,701,000	$24,071,100	$26,601,410	$29,283,375	$32,302,657
P.V.I.F @ 20%	0.8333	0.6944	0.5787	0.4823	0.4019	0.3349
P.V	$8,941,309	$15,069,174	$13,929,946	$12,829,860	$11,768,988	$10,818,160
Cumulative P.V	$73,357,437
TERMINAL CASH FLOWS:
Working capital release	$1,500,000
P.V @ 20% (1500000*0.3349	$502,350
Calculation of N.P.V:
P.V of annual cash flows (Year 1 - 6)	$73,357,437
P.V of terminal cash flows	$502,350
	$73,859,787
Less: Initial investment	$14,100,000
N.P.V	$59,759,787