Description

The University of Sydney

FINC2012: Corporate Finance II

 Semester 2 2024 Individual Assignment

Due 13th September 2024

(Maximum word limit: 1,500 words)

The Operations Department at PetroDynamics oversees all company activities related to gathering, purchasing, processing, and selling of oil. You are a recent graduate who was recently hired as a financial analyst to support the department. One of your tasks is to review the projections for a proposed ten-year oil purchase project created by one of the firm’s field engineers. The ten-year project’s cash flow projections are based on the following assumptions and estimates:

• The required initial capital expenditure for the project involves a $20 million cost to lay a new oil pipeline. The project is expected to be fully depreciated on a straight-line basis over its ten-year lifetime. The project is assumed to have no salvage value at the end of its life.
• The project requires an investment of $1,250,000 in net working capital at the project’s inception. This is assumed to be fully recovered at the end of the project.
• The oil well is expected to produce 1,000 barrels of oil per day in the first year, with production declining over the following nine years. The oil production is expected to decrease by 15% each year after the first year.
• A fee consisting of 60% of the wellhead oil market price must be paid to the oil producer. For example, if the wellhead market price is $100 per barrel, 60% ($60) is paid to the oil producer. This percentage is expected to remain constant over the life of the project.
• Other operational variable costs of $8.50 per barrel will be incurred in the project. These are also expected to be constant over the life of the project.
• The current oil price at the wellhead is $80 per barrel and is assumed to remain at this level over the entirety of the project’s life.
• The project’s cost of capital is 12%.
• The corporate tax rate is 35%.
• All dollar magnitudes are in nominal amounts.

Task 1 (5 marks): Based on the information and forecasts above, calculate the NPV and IRR for the proposed project. Should the project be adopted? Explain your answer. What reservations, if any, would you have about recommending the adoption of the project to your immediate Senior Manager? Justify your response.

Task 2 (4 marks): Perform and report the results of a sensitivity analysis seeking to determine which factors most significantly impact the NPV of the proposed project. Justify your answer as well as all of the assumptions underlying your analysis.

Task 3 (3 marks): Undertake and report the results of “breakeven analysis” on the proposed project’s key factors (or ‘value drivers’) underpinning its NPV.

Task 4 (6 marks): You have been informed that three alternative scenarios are also being considered for the oil pipeline investment project. These are outlined in the table below.

Possible Scenarios Being Considered

Scenario 1 Renewable Energy Acceleration Scenario	Scenario 2 Geopolitical Instability Scenario	Scenario 3 Environmental Policy Tightening Scenario
Accelerated investment in renewable energy, coupled with breakthroughs in energy storage and distribution, leads to a rapid shift away from fossil fuels. ▪A significant reduction in demand for oil due to the rapid adoption of renewable energy alternatives. ▪ Lower volumes of oil flowing through the pipeline reduce operational efficiency and increase per-unit transportation costs. ▪Governments impose additional taxes and restrictions on fossil fuel infrastructure to further incentivize the transition to renewables	Rising geopolitical tensions in key oil-producing regions lead to supply disruptions and uncertainty in global oil markets. ▪ Disruptions in supply chains cause a sharp increase in oil prices, boosting potential revenue for the pipeline. ▪ Increased risk and uncertainty lead to higher materials costs and insurance. ▪ Geopolitical instability could lead to disruptions in operations, reducing overall operational efficiency.	Governments worldwide implement stricter environmental policies to combat climate change, leading to increased regulatory burdens on fossil fuel infrastructure projects. •Reduced demand for fossil fuels because of a stronger push for renewable energy alternatives. • Increased complexity and compliance requirements reduce overall operational efficiency. •Significant increase in compliance costs due to stricter environmental standards.

 

While specific estimates and values for key variables within each scenario have not yet been finalized, a close colleague has proposed some preliminary figures that may be relevant. These preliminary estimates are summarized in the second table below.

Scenario 1: Renewable Energy Acceleration Scenario	Scenario 2 Geopolitical Instability Scenario	Scenario 3 Environmental Policy Tightening Scenario
• Oil price at the wellhead is $40 per barrel and constant over the life of the project. • Year 1 volume of 800 barrels of oil per day that declines by 15% each year after that. • Other operational variable costs increase to $10.50 per barrel and are constant over the life of the project. • New regulatory compliance costs of an additional $5.50 per barrel and are constant over the life of the project	• Oil price at the wellhead is $120 per barrel and constant over the life of the project. • Year 1 volume of 1100 barrels of oil per day that declines by 10% each year after that. • Other operational variable costs increase to $10.00 per barrel and are constant over the life of the project.	• Oil price at the wellhead is $65 per barrel and constant over the life of the project. • Year 1 volume of 900 barrels of oil per day that declines by 15% each year after that. • Other operational variable costs increase to $11.00 per barrel and are constant over the life of the project. • Additional environmental standard compliance costs of $9.00 per barrel and are constant over the life of the project.

 

Although your colleague’s assessments provide a useful starting point, you may wish to amend, modify, or extend these estimates to develop your own values for the key variables across the three scenarios.

As an additional element of your project analysis, undertake and report the results of scenario analysis utilising your own estimates and values of key variables across the three scenarios. Specifically, assess the NPV under each of the three scenarios. Ensure that you provide a clear and well-supported justification for the estimates and values you choose for each scenario.

Task 5 (7 marks): Write a clear and concise professional memo to your senior manager, summarising the results and conclusions of your project analysis as covered in Tasks 1, 2, 3 and 4. The memo should contain no more than one-page of text (single spaced, 12-point font) followed by at most with one additional page of supporting tables, figures etc. Include bullet points where appropriate and utilize bold and non-bold fonts to emphasize key points. Given that your Senior Manager reviews around twenty such memos daily, it is crucial that your communication is both clear and to the point. Aim to present the analysis in a way that facilitates quick comprehension of the key findings and their implications.

Note: The document containing your answers to Tasks 1 to 5 inclusive, as well as all Excel spreadsheet files supporting your analysis must be submitted.

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