Question

Permian Partners (PP) produces from aging oil fields in west Texas. Production is 1.82 million barrels per year in 2016, but production is declining at 9% per year for the foreseeable future. Costs of production, transportation, and administration add up to $25.20 per barrel. The average oil price was $65.20 per barrel in 2016. PP has 7.2 million shares outstanding. The cost of capital is 11%. All of PP’s net income is distributed as dividends. For simplicity, assume that the company will stay in business forever and that costs per barrel are constant at $25.20. Also, ignore taxes. [I highly recommend you create a spreadsheet for this 2016-2019 - Prof Mudd] a. Assume that oil prices are expected to fall to $60.20 per barrel in 2017, $55.20 per barrel in 2018, and $50.20 per barrel in 2019. After 2019, assume a long-term trend of oil-price increases at 7% per year. What is the ending 2016 value of one PP share? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Share value in 2016 $__________ b-1. What is PP’s EPS/P ratio? (Do not round intermediate calculations. Round your answer to 3 decimal places.) EPS/P ratio ___________ b-2. Is it equal to the 11% cost of capital? Yes No

Answer 1

In Years	2016	2017	2018	2019	2020
Production in miilion	1.82	1.6744	1.540448	1.417212
Cost of Production,Admin,transporatation per Barrel (a)	25.2	25.2	25.2	25.2
Average oil price per Barrel (b)	65.2	60.2	55.2	50.2
Earnings per Barrel 'c=a-b	40	35	30	25
Earnings in million	72.8	58.604	46.21344	35.4303
Dividend in Million	72.8	58.604	46.21344	35.4303
Total No shares	7.2	7.2	7.2	7.2
Dividend per Share(Dividend Growth rate assumed to be 7%) in 2020	10.11	8.14	6.42	4.92	5.27
Value of Equity = (Div 2017)/1+r+(Div 2018)/(1+r)2+(Div 2019)/(1+r)3+(Div 2020)/r-g)
Cost of Equity -11% DF		0.900901	0.811622	0.658731
		9.03	7.91	7.47	131.63
Value of Equity	156.05