Posted: August 28th, 2024

Fred has found some natural gas on his land and is now looking to sell the right

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

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$25,000

Fred’s cut

10% of revenues

What’s the Price for a Paper?

Starts at $10/page for undergrad, up to $21 for pro-level. Deadlines (3 hours to 14 days) and add-ons like VIP support adjust the cost. Discounts kick in at $500+—save more with big orders!

Price per mmbtu of natural gas

$6

Amount you already spent traveling to meet Fred

$2500

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Annual Inflation rate

0%

Expected life of well

10 years

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Salvage value of Equipment (sell in yr 10)

$25,000

Net working capital needs

10% of revenues

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Tax Rate

35%

Discount rate

14%

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. 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 Fred’s 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 “you can’t afford to miss” 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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