Overview:
You are an investment analyst for a large Dallas based oil company. The exploration team has reported a major success in West Texas and have asked you to evaluate the project and make a recommendation to management on whether to move forward in developing the oil field.
Key Assumptions:
The field only produces oil (its only source of revenue) and has a productive life of over 20+ years.
The oil field may be as large as 50,000,000 barrels (bbl.)
Initial production would occur in year 1 at 5,250 barrels (bbl.) per day
Production volumes will decline 5% every year
Oil is currently valued (and can be sold for) $50 per bbl. escalating in price by 2.5% per year
Variable costs (labor, operating expenses, electricity, etc.) are $18 per bbl. produced and escalate every year at 3%
There is a royalty that is owed to the landowner of 1/8th (12.5% of all sale revenues) throughout the entire duration of the project which is treated like any other cost
Fixed costs (headquarters, rentals, corporate allocations, etc.) are $12,500,000 per year and escalate 3% per year
Total sunk costs on the project to date are $23,000,000
Initial capital costs (CAPEX) spent in year 0 is $75,000,000
Additional CAPEX is $5,000,000 every other year starting in year 3
All CAPEX depreciates over 10 years from the time it was invested straight line method
The plant and equipment have no salvage value as any value remaining is used on expenditures to clean up the site when it is abandoned
The corporate tax rate is 35%
Incremental working capital is a non-issue and can be ignored
The company evaluates projects using a 12.5% discount rate
The project will have no corporate debt associated with it
Scenarios:
In evaluating the opportunity please consider the following:
Management likes to evaluate projects over a 10-year time horizon and using an annual view (not quarterly or monthly)
They like the analysis to include NPV, PV, IRR, and Payback Period analysis where it makes sense and are very interested in any projects FCF
There is no need to use Monte Carlo
Key factors they would want sensitized include a scenario where:
Oil prices started at $30 bbl. and stayed flat
Oil prices started at $60 bbl. and escalated 5% per year
Corporate discount rate of 10%
Corporate discount rate of 15%
Initial production volumes of 3,500 bbl. per day and decreased by 2% per year
Initial production volumes of 6,5000 bbl. per day and decreased 7% per year
Initial Capex of $105,000,000
Initial CAPEX of $55,000,000
Variable costs of $22 per bbl. produced escalating 5% per year
Variable costs of $24 per bbl. produced escalating 7% per year
Key Task
Please analyze the situation as described above using a single excel workbook (with multiple pages if you desire) drop in notes where it makes sense in the excel file so that it is understandable.
Calculate the valuation metrics that management would want to see for each scenario
Then write a one page memo (executive summary) describing the analysis and what your recommendation would be regarding the project. A single table might be helpful with metrics for the scenarios. How strongly do you feel about the recommendation? What factors are you most concerned about in terms of impacting value?