27 Dec Please submit all your work in th
FIN 494 Energy Finance: MW Petroleum Case
Please submit all your work in the Excel file provided, called “Data.”
1. (5 points) Explain why the right to develop Probable (Possible) reserves is essentially an American call option on the net cash flows that follow from capital expenditures required for development. Put the answer in the worksheet labeled “Essay Answers.”
2. (10 points) What is the strike price of the call option, K, for Probable Reserves? Refer to Exhibit 5, which shows extraordinary capital expenditures in the first four years. Find the present value of these extraordinary capital expenditures. Assume discount rate equal to the risk-free rate 8.24%. Show your calculations in the worksheet labeled “Exhibit 5.”
3. (10 points) What is the strike price of the call option, K, for Possible Reserves? Refer to Exhibit 6, which shows extraordinary capital expenditures in the first six years. Find the present value of these extraordinary capital expenditures. Assume discount rate equal to the risk-free rate 8.24%. Show your calculations in the worksheet labeled “Exhibit 6.”
4. (15 points) Discuss the assumptions that have been made in the estimation of strike price. Put your answers in the worksheet labeled “Essay Answers.”
a. We implicitly assumed that Apache cannot decide not to make the second year’s expenditures once it has made the first year’s expenditures. What if that wasn’t true, how would that impact the ultimate value of the option?
b. We implicitly assumed that Apache will have to decide on the development of the entire MW Petroleum reserve at once, i.e. it cannot decide property by property. If that wasn’t true, how would that impact the ultimate value of the call option?
5. (10 points) What is the value of the underlying asset, S, for Probable Reserves? This is the value of the asset if Probable Reserves were already developed, i.e. if the extraordinary capital expenditures needed for development weren’t required. Calculate the present value of cash flows provided in Exhibit 5 but excluding the capital expenditures in years 1-4, and discounting at the rate of 13% (just like you did in MW Petroleum Assignment 2 for PUD). Show your calculations in the worksheet labeled “Exhibit 5.”
6. (10 points) Repeat the previous step for Possible Reserves using Exhibit 6 and excluding cap
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