Pos Case I - Relevant Cash Flows and Risk Adjusting Technique Shell Oman engages in off-shore drilling operations for oil deposits The Strait of Hormux is a strait between the Persian Gulf and the Gulf of Oman. The company has recently spent S10 million in surveying a region in the Strait of Hormat and has found the existence of significant oil deposits there. The sea bed in the repion, however, has a rock formation that may make access to the oil deposits difficult. The total oil deposits in the region have been estimated at 50 million barrels but the amount extracted will vary according to the conditions faced when drilling operations commence. The company's senior geologist believes that three possible outcomes are likely from drilling operations and has made the following estimates concerning the percentage of total oil deposits that will be extracted under cach outcome Outcome Probability 1 2 3 Percentage of total oil deposits extracted 100% 4096 2596 0.1 05 0.4 If the company decides to go ahead with the drilling ration, an immediate payment of $20 million for drilling rights, along with annual payments of ss for each barrel of oil extracted must be made to the government Equipment costing $125 million must be acquired immediately but drilling will not commence until the second year of the four-year licence period. It is expected that, whichever of the above outcomes arise, the oil will be extracted evenly over the drilling period, Annual operating costs (excluding any payments to the government will be S120 million in the first year and 160 million for each of the remaining three years of the licence. At the end of the licence period, the equipment will be sold at a price that is equal to its original cost loss for each barrel of oil that has been extracted. oil prices over the period of the drilling licence are estimated to be as follows: Year Price per barrel $70 SUS 3 575 S100 The company has a cost of capital of 14%. No tax rate is applicable Required: (a) Identify the relevant cash flow in above case and calculate Cash flow after tax for four years. (5 marks) (b) Calculate the expected nel present value (ENPV) of the investment proposal 1 4 GO Pos Case I - Relevant Cash Flows and Risk Adjusting Technique Shell Oman engages in off-shore drilling operations for oil deposits The Strait of Hormux is a strait between the Persian Gulf and the Gulf of Oman. The company has recently spent S10 million in surveying a region in the Strait of Hormat and has found the existence of significant oil deposits there. The sea bed in the repion, however, has a rock formation that may make access to the oil deposits difficult. The total oil deposits in the region have been estimated at 50 million barrels but the amount extracted will vary according to the conditions faced when drilling operations commence. The company's senior geologist believes that three possible outcomes are likely from drilling operations and has made the following estimates concerning the percentage of total oil deposits that will be extracted under cach outcome Outcome Probability 1 2 3 Percentage of total oil deposits extracted 100% 4096 2596 0.1 05 0.4 If the company decides to go ahead with the drilling ration, an immediate payment of $20 million for drilling rights, along with annual payments of ss for each barrel of oil extracted must be made to the government Equipment costing $125 million must be acquired immediately but drilling will not commence until the second year of the four-year licence period. It is expected that, whichever of the above outcomes arise, the oil will be extracted evenly over the drilling period, Annual operating costs (excluding any payments to the government will be S120 million in the first year and 160 million for each of the remaining three years of the licence. At the end of the licence period, the equipment will be sold at a price that is equal to its original cost loss for each barrel of oil that has been extracted. oil prices over the period of the drilling licence are estimated to be as follows: Year Price per barrel $70 SUS 3 575 S100 The company has a cost of capital of 14%. No tax rate is applicable Required: (a) Identify the relevant cash flow in above case and calculate Cash flow after tax for four years. (5 marks) (b) Calculate the expected nel present value (ENPV) of the investment proposal 1 4 GO
