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Finance 既長問題 part A

ROC Oil Limited has recently undertaken a preliminary drilling exercise, costing $1,200,000 to complete, at a land site in Northern Western Australia where its initial geological surveys indicated that a significant oil deposit existed. This preliminary drilling assessment has convinced the company that there is a viable reserve of oil which should be accessible on a cost-effective basis, particularly given the current high level of world-wide oil prices. The company estimates that the oil reserves will have a 20-year useful life, based on a production schedule of 150,000 barrels of oil per year. The company has entered into a long-term contract to supply this oil to the Chinese Government at a cost of $80.00 per barrel. The company estimates that operating and extraction costs will average $45.00 per barrel, and other fixed costs of $800,000 per year will be incurred. The company estimates that it will cost $20,000,000 to establish the oil drilling facility and to construct the pipeline infrastructure to transport the oil to the Port of Darwin for shipping to China. Re-location and establishment expenses for the housing of employees staffing the oil drilling facility will be $2,500,000 and an additional $2,000,000 in net working capital will be required at commencement of the project. This net working capital investment will be recouped at the end of the project. It is expected that mining equipment and the pipeline infrastructure will be able to be sold for $8,000,000 at the end of the project, and dismantling costs of $5,000,000 will be incurred at this time to environmentally repair the land site and finalise the oil drilling project. The company can claim annual prime-cost (straight-line) depreciation deductions against the installed cost of the project, and the company faces a 30% corporate tax rate on cash flows generated by the project.

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1 Answer

Rating
  • Wai I
    Lv 5
    1 decade ago
    Favorite Answer

    (a) The WACC has 3 components

    1. cost of equity: [0.4x(1+0.04)]/4.28 +0.04 = 13.71962616822%

    2. cost of debt 1: [0.1x(1-0.3)] = 7%

    3. cost of debt 2: [0.08x(1-0.3)] = 5.6%

    Total fund = $12,500,000 + $10,000,000 + $2,000,000

    =$24,500,000

    We = $12,500,000/$24,500,000= 0.510204081632653

    Wd 1 = $10,000,000 /$24,500,000 =0.408163265306122

    Wd 2 = $2,000,000 /$24,500,000=0.0816326530612245

    WACC = We*cost of equity +Wd1*cost of debt1+Wd2*cost of debt2

    WACC=0.103140949837879 = 10.3141%

    b) The inital capital for the project =

    $1,200,000+$20,000,000+$2,500,000+$2,000,000 = $25,700,000

    yearly depreciation cost for the oil drillng facility = (20,000,000-8,000,000)/20 = 600,000

    yearly depreciation cost for the housing facility = 2,500,000/20=125,000

    Profit tax for every year = (4,450,000 - 600,000-125,000)*0.3 = 1,117,500

    Profit tax for year 20 = 0 as the accounting profit will be negative for this project

    Yearly activity cash flow = $(80-45)*150,000 - $800,000 -1,117,500= $3,332,500

    Cash flow for the final year (year20) = 4,450,000+2,000,000+8,000,000-5,000,000 = 9,450,000

    discount rate = i = 10.3141%

    NPV = - 25,700,000 + 3,332,500*[1-(1+i)^-19]/i +9,450,000/(1+i)^20

    =$2,932,597.52

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