Question

In: Finance

Payback period and NPV​ calculations)  Plato Energy is an oil and gas exploration and development company...

Payback period and NPV​ calculations)  Plato Energy is an oil and gas exploration and development company located in​ Farmington, New Mexico. The company drills shallow wells in hopes of finding significant oil and gas deposits. The firm is considering two different drilling opportunities that have very different production potentials. The first is in the Barnett Shale region of central Texas and the other is in the Gulf Coast. The Barnett Shale project requires a much larger initial investment but provides cash flows​ (if successful) over a much longer period of time than the Gulf Coast opportunity. In​ addition, the longer life of the Barnett Shale project also results in additional expenditures in year 3 of the project to enhance production throughout the​ project's 10-year expected life. This expenditure involves pumping either water or

CO 2CO2

down into the wells in order to increase the flow of oil and gas from the structure. The expected cash flows for the two projects are as​ follows:  

LOADING...

.

a.  What is the payback period for each of the two​ projects?

b.  Based on the payback​ periods, which of the two projects appears to be the best​ alternative? What are the limitations of the payback period​ ranking? That​ is, what does the payback period not consider that is important in determining the value creation potential of these two​ projects?

c.  If​ Plato's management uses a discount rate of

21.621.6

percent to evaluate the present values of its energy investment​ projects, what is the NPV of the two proposed​ investments?

d.  What is your estimate of the value that will be created for Plato by the acceptance of each of these two​ investments?

Year

Barnett Shale

Gulf Coast

0

​$(4 comma 600 comma 0004,600,000​)

​$(1 comma 100 comma 0001,100,000​)

1

1 comma 840 comma 0001,840,000

825 comma 000825,000

2

1 comma 840 comma 0001,840,000

825 comma 000825,000

3

​(920 comma 000920,000​)

375 comma 000375,000

4

1 comma 840 comma 0001,840,000

120 comma 000120,000

5

1 comma 640 comma 0001,640,000

6

1 comma 640 comma 0001,640,000

7

1 comma 640 comma 0001,640,000

8

850 comma 000850,000

9

650 comma 000650,000

10

150 comma 000150,000

Solutions

Expert Solution

a)
PBP Project Barnett Shale Project Gulf Coast
Time Amount Cumulative Amount Cumulative
                                                                              -   (4,600,000.00) (4,600,000.00) (1,100,000.00) (1,100,000.00)
                                                                         1.00      1,840,000.00 (2,760,000.00)         825,000.00       (275,000.00)
                                                                         2.00      1,840,000.00       (920,000.00)         825,000.00         550,000.00
                                                                         3.00       (920,000.00) (1,840,000.00)         375,000.00         925,000.00
                                                                         4.00      1,840,000.00                           -           120,000.00      1,045,000.00
                                                                         5.00      1,640,000.00      1,640,000.00
                                                                         6.00      1,640,000.00      3,280,000.00
                                                                         7.00      1,640,000.00      4,920,000.00
                                                                         8.00         850,000.00      5,770,000.00
                                                                         9.00         650,000.00      6,420,000.00
                                                                       10.00         150,000.00      6,570,000.00
Payback period 4 Years 1 + 275,000 /825,000
Payback period 4 Years 1.33 Years
b) Project Gulf Coast as it has payback period of 1.33 Years
Paybackignores time value of money and ingores future cash flows once investment is recovered
c)
Statement showing Cash flows Project Barnett Shale Project Gulf coast
Particulars Time PVf 21.6% Amount PV
Cash Outflows                           -                        1.00 (4,600,000.00) (4,600,000.00) (1,100,000.00) (1,100,000.00)
PV of Cash outflows = PVCO (4,600,000.00) (1,100,000.00)
Cash inflows                      1.00                  0.8224      1,840,000.00      1,513,157.89         825,000.00         678,453.95
Cash inflows                      2.00                  0.6763      1,840,000.00      1,244,373.27         825,000.00         557,939.10
Cash inflows                      3.00                  0.5562       (920,000.00)       (511,666.64)         375,000.00         208,559.77
Cash inflows                      4.00                  0.4574      1,840,000.00         841,556.97         120,000.00            54,884.15
Cash inflows                      5.00                  0.3761      1,640,000.00         616,844.89                           -  
Cash inflows                      6.00                  0.3093      1,640,000.00         507,273.76                           -  
Cash inflows                      7.00                  0.2544      1,640,000.00         417,165.92                           -  
Cash inflows                      8.00                  0.2092         850,000.00         177,807.60                           -  
Cash inflows                      9.00                  0.1720         650,000.00         111,817.86                           -  
Cash inflows                    10.00                  0.1415         150,000.00            21,220.49                           -  
PV of Cash Inflows =PVCI      4,939,552.03      1,499,836.97
NPV= PVCI - PVCO         339,552.03         399,836.97
d) Project Barnett Shale Project Gulf coast
Value created         339,552.03         399,836.97

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