Question

1) What would you prefer, an annual cash flow of $600 for 4 years, or a lump sum payment of $2,500 in year 4? Your discount rate is 4.25%. Please discuss.

2) Our refinery has a remaining life of 3 years, and is fully utilised processing 1.5 million barrels of crude oil per annum at a processing cost of $10.00 real per barrel. By modifying the refinery at a cost of $6 million we can reduce the processing cost to $8.50 real per barrel. We can depreciate this capital cost fully on a straight line basis over the residual 3-year life of the operation. The corporate tax rate is 30%. Should we modify the plant if our real discount rate is 5% and we expect inflation to be 1.75%?

3) Calculate the 3-month futures on crude oil, gasoline and distillate if the current spot prices are $49.35, $55.11 and $43.10 respectively, with a prevailing risk-free rate of 1.25%. To store crude oil and gasoline, it costs $4 and $1.50 per barrel respectively, payable upon removal. The cost to store distillate is a constant 3% of the price. Using these futures, calculate the profit margin that can be locked in using a 3-month 3-2-1 crack spread.

4) The price quoted for constructing a plant in June 2013 was $32M. What would you estimate its cost to be: a. In June 2020 if inflation has averaged 2% over the period? (1 mark) b. In December 2020 if the cost has escalated at 1.25% above CPI in real terms?

5) Identify each of the seven transport costs determinants.

6) Grease currently fetches a price of $300 per ton. To make one ton of grease, $80 worth of crude oil and $50 worth of emulsified soap is required. If it is assumed that $60 of domestic input is required to produce one ton of grease, what is the effective rate of protection (ERP) for domestically produced grease if the following tariffs exist: • 10% tariff on imported grease; • 6% tariff on imported crude oil; and • 5% tariff on imported emulsified soap.

7) Provide a clear outline of what factors are captured in the weighted average cost of capital (WACC) and what additional factors may be captured in a discount rate. 3 8) Can the Beta, as used in the CAPM calculation, ever be a negative value? Explain your answer.

9) A drilling contractor deploys an inexperienced drilling crew for a specific exploration programme, believing that this crew will, under the direction of a highly experienced manager, improve at a rate of 70% based on their learning curve. The first drill hole took 150 days to complete. How long will it take to drill:

a) the 4th hole? b) the 10th hole? c) the 50th hole? d) the 101st hole?

Answer 1

Ans. The present value of the annual cash flow of $600 at 4.25% interest rate is,

PV = 600/(1+0.0425) + 600/(1+0.0425)^2 + 600/(1+0.0425)^3 + 600/(1+0.0425)^4

=> PV = $2165.17

The present value of the $2400 lumpsum payment at 4.25% interest rate is,

PV = 2400/(1+0.0425)^4

=> PV = 2031.92

Thus, with higher present value, the periodic payment of $600 is better than the lump sum payment of $2400.

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