WONDAENERGY plc formed in 1995 and specialise in oil exploration and production. Last year the company made sales of over 700 million and achieved a net profit pre-tax of 68 million, based on an equity employed of 240 million, as announced in the annual report for their year ended 31 December 2022.

The company has the option to enter into an agreement with the government of Boaland (a country with a developing economy but rich in natural resources) to develop and produce oil from the recently discovered Swift field. The governments geologists believe that there are 3,200,000 barrels of oil in this specific off-shore field under consideration. The contract states that all development, production and transportation operations will be the responsibility of WONDAENERGY but that 40% of any oil extracted will be the property of the Bravaland government. The government will pay their share of costs but only those relating to the variable costs of production and 40% of the transportation costs. WONDAENERGYs geologists believe that they are confident that 70% of the reserves predicted by the government are certain. The company will only extract the oil and transport it to the wholesale market on the mainland. Production is expected to be released from the field as follows: 2025 10%; 2026 17%; 2027 28%; 2028 20%; 2029 10%; 2030 10%; 2031 3%;2032 2%.

The price of oil at present at the wholesale market is 60 per barrel. The variable costs of production are 31 per barrel. There are incremental fixed costs attached to the project of 1,400,000 per annum regarding support costs for the project once production commences. In addition to this there are transportation costs, which is an area of difficulty to the company as there is no oil pipe network within the near vicinity. The company has therefore outsourced this to a tanker transportation company who specialise in moving oil from source to market. However, the costs being charged is a fixed cost based on volumes extracted each year. The costs behave in a stepped fashion at 500,000 for the first 300,000 barrels of oil transported in a year jumping to 900,000 for volumes over this. In addition to these costs there will be development costs of 750,000 in 2024. On completion of production there are environmental reinstatement costs of 1,300,000.

There will be initial capital expenditure of 10,000,000 at the start of 2024 to set-up and equip the drilling sites. It is estimated that the lease when operational will have a life cycle of 8 years and be capped and reinstated when production ceases. At the end of this period the drill-rigs and equipment purchased in 2024 will be sold for 700,000.

All figures quoted above are at current prices. Cost inflation is expected to be 1.9% per annum and is also relevant to the disposal value of the non-current assets. The oil prices are likely to rise by 1.7%. The company at present uses a post-tax market cost of capital of 11.3%.

Required:

a) Calculate the net present value and internal rate of return for the project as outlined above and based on WONDAENERGYs geologists forecast, which offers a more prudent estimate that we can have confidence in.