Question

Suppose an oil company is considering whether to develop production facilities for a newly discovered oil field on lands owned by a state government. If the firm spends $2 billion in present value in capital costs, it could install facilities capable of producing 80,000 barrels per day. Annual operating costs for the oil field are anticipated to be $30 per barrel produced. The company expects production from the field to start at 80,000 barrels per day but then decline at 9 percent annually indefinitely. The firm has to pay its investors a 10 percent annual return.

If the oil price is expected to remain constant at $60 per barrel, what would be the gross revenues in the first year of production, and the present value of projected total gross revenues from the field? The firm's managers use the rate of return investors need as the discount rate. (Again, show details of your calculation).

Answer 1

Please note that costs have not been taken into account since the question asked for gross revenues.