Suppose that an oil well is expected to produce 100,000 barrels of oil during its first year in production. However, its subsequent production is expected to decrease by 10% over the previous year’s productionl. The oil well has proven reserve of 1,000,000 barrels. Suppose that the price of oil is expected to start at $60 per barrel during the first year but it will increase at the rate of 5% over the previous year’s price. What would be the present worth of the anticipated revenue stream at an interest rate of 12% compounded annually over the next 7 years?

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EXPERT ANSWER

YearBarrelsPriceRevenues
1100,000$60.00$     6,000,000
2    90,000$63.00$     5,670,000
3    81,000$66.15$     5,358,150
4    72,900$69.46$     5,063,452
5    65,610$72.93$     4,784,962
6    59,049$76.58$     4,521,789
7    53,144$80.41$     4,273,091
PW$23,847,896.70

Forecast the no. of barrels and price per barrel as shown in the table above.

No. of barrels next year = No. of barrels this year x (1 – 10%)

Price per barrel next year = Price per barrel this year x (1 + 5%)

Revenues = Price x Quantity

Present worth can be calculated using NPV formula in excel/calculator or using TVM formula manually.

PW = NPV(12%, 6000000…4273091) = $23,847,896.70