# Chapter 7 Case Study

Chapter 7 Case Study
Team 4:
Kyle Lock
Amanda Mock
Jeff Morris
Derrick Plunk
Brian Wilder
9/29/2009
Chapter 7 Case Study .................................................................................................................................... 3
Question 1 ................................................................................................................................................. 3
Question 2 ................................................................................................................................................. 3
Question 3 ................................................................................................................................................. 3
Question 4 ................................................................................................................................................. 3
Question 5 ................................................................................................................................................. 4
Question 6 ................................................................................................................................................. 4
Chapter 7 Case Study
September 29, 2009
Chapter 7 Case Study
Question 1
How much money would you make if there were no costs of extraction? Would this be enough to retire?
At the current price of \$18.36 per barrel multiplied by the estimated 1,500,000 barrels of oil
underground, which would give you \$27,540,000. Subtract out the \$1 million dollar lease and you still
net \$26.54 million. Yes, that amount would be sufficient to retire on.
Question 2
Would you indeed lose money if you leased and extracted immediately, considering the cost of
extraction? How much money?
Yes, you would lose money. \$27,540,000 - \$1,000,000 (lease) - \$30,000,000 (extraction expense) =
(\$3.46 mil)
Question 3
Continue the scenario analysis by computing the future net payoff implied by each of the future prices of
oil. To do this, multiply the price of oil by the number of barrels, then subtract the cost of extraction. If
this is negative, you simply wonâ€™t develop the field, so change negative values to zero. (At this point, do
not subtract the lease cost, because we are assuming that it has already been paid.)
\$
\$
\$
\$
\$
Oil Price
10.00
15.00
20.00
25.00
30.00
\$
\$
\$
\$
\$
Quantity of Oil
1,500,000.00
1,500,000.00
1,500,000.00
1,500,000.00
1,500,000.00
\$
\$
\$
\$
\$
Profit
15,000,000.00
22,500,000.00
30,000,000.00
37,500,000.00
45,000,000.00
Cost
\$ (30,000,000.00)
\$ (30,000,000.00)
\$ (30,000,000.00)
\$ (30,000,000.00)
\$ (30,000,000.00)
Net
\$
\$
\$
\$ 7,500,000.00
\$ 15,000,000.00
Question 4
Find the average future net payoff, less the cost of the lease. How much, on average, would you gain (or
lose) by leasing this oil field? (You may ignore the time value of money.)
The average future net payoff is \$20/barrel. This gets you to the break-even point.
No profit or loss unless you include the lease, then you would have a \$1mil loss.
Page 3
Chapter 7 Case Study
September 29, 2009
Question 5
How risky is this proposition?
With the fixed future prices that are given to us, you only have a 30% of making a profit. The standard
deviation is \$5.48 million. This shows that there is considerable risk involved. Profits could reasonably be
\$5.48 mil above or below its mean value of \$20/barrel, which only brings us to the break-even point.
Question 6
Should you lease or not?
This investment does seem to be fairly risky, but with high risk can come high reward.
I would need to know more information before proceeding with this investment, such as the following
items:
a) Current oil reserve levels
b) Current state of the economy
c) President
d) Price trends
e) Historical oil prices
Page 4
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