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Posted: August 28th, 2024
Fred has found some natural gas on his land and is now
looking to sell the right to drill for this gas. Assume that you are a CFO of a
natural gas producer. You have traveled to meet with Fred and he now wants to
how much you are willing to pay for this right. As noted below, in addition to
the proceeds he will receive from selling this right, Fred will also receive
10% of the revenues from the project. Your company will pay for equipment and
all other expenses associated with this project.
More details on the project:
Drilling equipment
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$1,000,000
Expected amount of natural gas to be extracted:
100,000 mmbtu per year
Annual maintenance cost
$25,000
Fredâs cut
10% of revenues
Price per mmbtu of natural gas
$6
Amount you already spent traveling to meet Fred
$2500
Annual Inflation rate
0%
Expected life of well
10 years
Salvage value of Equipment (sell in yr 10)
$25,000
Net working capital needs
10% of revenues
Tax Rate
35%
Discount rate
14%
. 1.) What is the internal rate of return on this
project?
. 2.) What is the net present value of this project?
. 3.) How much are you willing to pay for the right
to drill on Fredâs land? When making your decision, keep in mind that there is
a good chance that Fred is also talking to other companies about this.
. 4.) Not to be outdone, brother-in-law Chip comes to
you with an alternative âyou canât afford to missâ opportunity. He is asking
your company for $1,000,000. This investment is expected to return $1,400,000
at the end of next year (i.e., end of year 1). After some basic analysis you
have decided that the appropriate discount rate for evaluating this project is
14 percent. You can not help out Fred and Chip. Who do you help?
. 5.) Is there any other information that you would
like to know before going forward with this? Note any key assumptions
underlying your analysis.
type up your answers to these questions in a word
document, with an excel table showing clearly the calculation of cash flows,
and calculation of present value, IRR.
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