The Profitability of the Given Investment - Coursework Example

ASSET MANAGEMENT 2 Question Task The Discount Rate In the selection of a discount rate for use, two major considerations are made as ways of ensuring that a comprehensive investment analysis method is selected. These considerations are the internal rate of return (IRR) and net present value (NPV). The internal rate of return is made on discount rate as it represents the effective interest rate that the company enjoys on its investments (Muller, 2002, p ixx). The net present value on the other hand gives a measure of the difference between present value of cash inflows and existing value of cash outflows (Ankomah, 2005, p. 73). These two are considered viable considerations because they aid in analyzing the profitability of the given investment. Given the 6 projects that have been earmarked by the company, the best form of discount rate that will be preferred would be the Weighted Average Cost of Capital. This is selected against the backdrop that it helps in identifying the cost of working capital available to the company (Muller, 2002, p 36). This is done by way of calculating the individual rates at which the company is expected to execute payment on average to its securities so as to clear or finance its capital assets. The weighted average cost of capital (WACC) is preferred over others as it holds the potential of ensuring that payment of security holders are not done offhand but on an average basis to ensure that the net present value can be measured. Task 2: Optimisation Development Drilling In its generalized form, it is important to establish that the optimization of the CAPEX and OPEX are both directed at the generation of capital fund revenue for the company: only that they are to be done in two different fashions. For the 100m CAPEX, any spending decisions made on it must be one that can potentially increase the wealth or value of assets that are already in place and that will become useful beyond the given tax year (Cliff, 2009, p. 83). On the part of the 20m OPEX, it would also be expected to be used in a more value for money fashion even though they have to be used to cater for expenses that will be incurred whiles the project is underway (Investopedia, 2012). Given the prevailing background, it is strongly recommended that for the development drilling, both G-3 and G-4 be drilled in 2015. This is because of the collective wealth creation that will accrue from the two wells when drilled concurrently. For example, it is said that the value of G-1 will decline by a percentage rate of 8% per annum. What this means is that if the company would opt for periodic drilling whereby it would consider drilling G-3 alone in 2015 and drilling the G-4 in subsequent years, the quantitative value of well will be reduced. What is more, there are rooms for uncertainties, which may mean that the 8% decline per annum would even worsen. Having made all these points, it is perfectly agreed that the drilling of the two wells at a go will come with a large tone of outright expenditure but considering the fact that the percentage of capital expense in that expenditure will be higher than the operational expense, the company cannot be said to be on a losing way if this action is taken. Spending on Sidetracks Clearly, to sidetrack the coastal wells will yield very little economic value to the project as the sidetracks do not guarantee any reasonable tapping of inaccessible oil. Worse of all, it is presently not prudent to convert them to water injection service as the economic pre-screening suggests. In the light of all of this, the best recommendation that is given on the long reach coastal wells is for the project seekers to undertake selective sidetracks. This is recommendation is made against the background that a decision to totally ignore the long reach coastal wells N-7, N-8, S-7, S-8 and S-9 will be a major hindrance to the reservoir connectivity and projected sequence of the workflow. In this regard, the medial coastal wells namely S-7, S-8 and N-7 are recommended to be sidetracked. If for nothing at all, for the year 2015, only a part of the available long reach coastal wells can be sidetracked. Given the fact that the economics of each will be as for one fifth of the major project also, not much of the available expenditure in the form of capital expenditure and operational expenditure will be expected to be invested in this area. Particularly so for there to be a cut out on the cost of these sidetracks is the fact that the sidetrack yields no direct economic benefit for the project owners in terms of oil extraction (Ruddick, 2012) and would therefore come under the revenue expenditure. Meanwhile, this is expenditure with a total worth of 20m only and so should not be channelled towards sectors with no proven economic yielding. CAPEX and OPEX allocation to Corrosion Workovers Spending on the corrosion workovers out of the stipulated 100m CAPEX and 20m OPEX would be based mainly on the timing within which these operations could be completed. The implication here is that already, the need to have a combined development drilling for project one is being advocated and so not much extra-drilling costs can be incurred. However, each of the vertical wells S-5 and S-6 could have their own economic benefits if invested into and added to the volume of oil that can be drilled. Ideally therefore, selective workover needs to be done. If for nothing at all, when investment is made with special steel in completion, there will be a reduction in the annual failure rates by 15%, which could be calculated in economic wise to mean some substantial wealth of money. In relation to the selection of which of the wells to be repaired, premium will be placed on proximity in the sense that a technique of using special steel, which could have a high rising economic impact will be used. In light of this, it would be necessary to limit all possible untracked expenses. Using proximity to select the closes well among the two would also ensure that the time to be carried out in undertaking this project is beaten down so that intensive work can begin on the combined development drilling. Finally, the movement of equipment to the site for the repair works will be favoured and this will in turn cut down on cost if proximity measures are used to select the closest among the two well for repairs to take place. Benefit analysis for repairing Sand Screen Change-out Workovers Financial decision on the vertical wells N-4 and N-6 in relation to the stipulated funds shall be made based on the fact that undertaking repair works on either of the wells will not make it possible to include both in the plan for 2015. Therefore, a rapid cost benefit analysis shall be undertaken to determine which of the options: be it undertaking the repairs and abandoning the mega 2015 plan or vice versa would yield more value for money. But with a very critical analysis, it can be noted that keeping the sand screens still closed would come with great financial benefit to the company. This is because of the time involved in the delivery of the replacement of each of the sand screens. Presently, each of the workovers will take a period of 3 week and shall constitute a huge financial placement out of the available 100m and 20m for CAPEX and OPEX respectively. Considering the fact that wells G-3 and G-4 are projected to be undertaken concurrently, it would be highly economically prudent to be economical with spending. Already, three long reach coastal walls are also going to have workovers undertaken on them and so it would only be appropriate to keep the sand screen change-out workovers for N-4 and N-6 suspended for the 2015 season so that remaining project tasks for the given year can successfully take place without incurring any extra expenses and costs that cannot be accounted as having vibrant future returns. The repair works on N-4 and N-6 should therefore be suspended for now. Cost spending on Onshore ESPs It is indeed a very justifiable decision that the repair on the sand screens will be suspended till feature notice. This is because of the preference that onshore ESPs should have over the repairs on sand screen workivers and the implications that each of those two works have on the other. For example it is known that installing ESPs along side the repair work would incur extra working days from the already limited time to undertake two mega installations of wells namely G-3 and G-4. Against this backdrop that the repair works have been suspended to make way for time and funds to be saved for other cost effective projects to take place, it is recommended that greater value of the existing OPEX and CAPEX be injected into the installation of all four onshore ESPs. Even though the commercial value of available oil to be tapped from that investment has been described as minimal, it is the fact that impact of each ESP is approximately to restore a well to its production rate of 2 years earlier is the best reason why this will be considered as a very useful and viable investment to take. For the fact that a 2-tier well drilling developments are being undertaken, the two year projected restoration will create a situation whereby in the nearest future, a lot more extraction outputs shall be guaranteed for future investments. Finally, it is strongly recommended that the installation be done after November 10, 2015 so that some extraction benefits will not be denied as the 4 candidate workover wells await repairs. Offshore ESPs Clearly, commitments into the offshore ESPs would impact greatly on the financial fortunes and the asset allocation of the company. This is because a decision to undertake offshore ESP installations together with onshore ESP installations would demand and extra financial asset input of $36m, which would be more incrementing to the stipulated allocation of $100 CAPEX allocation. This therefore brings up a decision of undertaking the installation on a partial basis as the potential future capital yielding revenues cannot be overlooked. On the basis of this, another call for the use of proximity to determine the best out of the two wells namely A-1 and B-1 be done to select one of the wells to benefit from the installation of the offshore ESPs. Unlike the onshore installation, the offshore installation will come with the demands of cabling and electrical hook-up and as such, it will be just prudent that time and cost cutting measures be undertake to ensure that the works do not interfere with the general work to be undertaken in 2015. Task 3: Handling Data Uncertainties The solution approach will be tailed in relation to the internal rate of return (IRR) when the predicted economic performance of the present oil drilling project is placed at a value of $90 to $110/bbl from 1st July 2014. With this, once the internal rate of return (IRR) exceeds the predicted hurdle, the asset management team and for that matter the asset manager can easily get the indication of the need to proceed with the project. But if the internal rate of return (IRR) does not reach the threshold or hurdle, then the best action to take would be to reject the present state of the value (Gardener, 2001, p. 122). With the given values, the input value can easily be found to undertake an input into the prevailing PERT. Subsequently, the critical path method (CPM) will be computed in coming out with a model that best yields commercial monetary value for the current range. In practice therefore, the gas price will be approached such that all major dependencies that would ensure that the maximum price is reached will be advocated while shedding less focus for dependencies that shifts the price towards the minimum. In its worse form scenario, the least bargain that should be permitted should be that of the mode or average cost price. Cost estimate range of +/-10% is rather on the higher sides and would need rapid intervention that is aimed at reducing the range. Even though the range could generally accepted to an average of the actual cost inflows and outflows, it is always alarming to leave the estimates at such higher ranges when the calculations of the accounting team can be trusted. What is even more disturbing is the fact that the company will be dealing with a situation whereby very huge market cost will be dealt with. Consequently, the range of 10% from such values when quantified would give a turnover of huge prices. REFERENCE LIST Gardener, R. A, 2001, Financial Complexities in Global Market. London: Zion Press Limited Ruddick G, 2012, International Power sweetens GDF Suez merger with £1.4bn cash for investors, The Telegraph [Online] http://www.telegraph.co.uk/finance/newsbysector/energy/7936043/International-Power-sweetens-GDF-Suez-merger-with-1.4bn-cash-for-investors.html [Accessed March 16, 2012] Investopedia. Microeconomics. 2012. Web. March 27, 2012 Cliff, T. 2009. International Trade Potentials. Cairo: Mighty Press Limited. Muller, S. 2002. Macroeconomic Indicators and Reactors. Munich. Alpha Publishers. Ankomah, D. 2005. Dispensing Economic Partnership and Trade Reviews. New York: Dynamite Press Series. Read More