Problem 3-12 CONCOPHILIPS GAS ACQUISITION PROJECT complete solutions correct answers key

Problem 3-12 CONCOPHILIPS GAS ACQUISITION PROJECT complete solutions correct answers key

ConocoPhillips (COP) Natural Gas and Gas Products Department (NG&GP) manages all of the company's activities relating to the gathering, purchase, processing, and sale of natural gas and gas liquids. Chris Simpkins, a recent graduate, was recently hired as a financial analyst to support the NG&GP department. One of Chris's first assignments was to review the projections for a proposed gas purchase project the were made by one of the firm's field engineers. The cash flow projections for the 10-year project are found in Exhibit P3-12.1 and are based on the following assumptions and projections:

·         The investment required for the project consists of two components: First, there is the cost to lay the natural gas pipeline of $1,200,000. The project is expected to have a 10-year life and is depreciated over seven years using a seven-year modified accelerated cost recovery system (MACRS). Second, the project will require a $145,000 increase in net working capital that is assumed to be recovered at the termination of the project.

·         The well is expected to produce 900,000 cubic feet (900 MCF) per day of natural gas during Year 1 and then decline over the remaining nine-year period (365 operating days per year). The natural gas production is expected to decline at a rate of 20% per year after Year 1.

·         In addition to the initial expenditures for the pipeline and additional working capital, two more sets of expenses will be incurred. First, a fee consisting of 50% of the wellhead natural gas market price must be paid to the producer. In other words, if the wellhead market price is $6.00 per MCF, 50% (or $3.00 per MCF) is paid to the producer. Second, gas processing and compression costs of $0.65 per MCF will be incurred.

·         There is no salvage value for the equipment at the end of the natural gas lease.

·         The natural gas price at the wellhead is currently $6.00 per MCF.

·         The cost of capital for this project is 15%.

a.) What are the NPV and IRR for the proposed project, based on the forecasts made above? Should Chris recommend that the project be undertaken? Explain your answer. What reservations, if any, should Chris have about recommending the project to his boss?
 

b.) Perform a sensitivity analysis of the proposed project to determine the impact on NPV and IRR for each of the following scenarios:
1.) Best case: a natural gas price of $8.00 and a Year 1 production rate of 1,200 MCF per day that declines by 20% per year after that.
2.) Most likely case: a natural gas price of $6.00 and a Year 1 production rate of 900 MCF per day that declines by 20% per year after that.
3.) Worst case: a natural gas price of $3.00 and a Year 1 production rate of 700 MCF per day that declines by 20% per year after that.
 

c) Do breakeven sensitivity analysis to find each of the following:
1) Breakeven natural gas price for an NPV = 0.
2) Breakeven natural gas volume in Year 1 for an NPV = 0.
3) Breakeven investment for an NPV = 0.
 

d) Given the results of your risk analysis in parts b and c, would you recommend this project? Explain your answer

Year

0

1

2

3

Investment

$ 1,200,000

Increase in NWC

145,000

MACRS depreciation rate  (7 years)

0.1429

0.2449

0.1749

Natural gas wellhead price  (per MCF)

$      6.00

$      6.00

$     6.00

Volume (MCF/day)

900

720

576

Days per year

365

Fee to producer of natural gas (per MCF)

$      3.00

$      3.00

$     3.00

Compression and processing  costs (per MCF)

0.65

0.65

0.65

Cash Flow Calculations

Natural gas wellhead price revenue

$ 1,971,000

$ 1,576,800

$1,261,400

Lease fee expense

985,500

788,400

630,720

Compression and processing costs

213,525

170,820

136,656

Depreciation expenses

171,480

293,880

209,880

Net operating profit

600,495

323,700

284,184

Less taxes (40%)

(240,198)

(129,480)

(113,674)

Net operating profit after tax (NOPAT)

360,297

194,220

170,510

Plus depreciation

171,480

293,880

209,880

Return of net working capital

Project free cash flow

$(1,345,000)

$ 531,777

$ 488,100

$ 380,390

Exhibit P3-12.1 Analysis of the ConcoPhilips Gas PurchaseProject

Alternate View

4

5

6

7

8

9

10

0.1249

0.0893

0.0893

0.0893

0.0445

$     6.00

$ 6.00

$ 6.00

$ 6.00

$ 6.00

$ 6.00

$ 6.00

461

369

295

236

189

151

121

$     3.00

$ 3.00

$ 3.00

$ 3.00

$ 3.00

$ 3.00

$ 3.00

0.65

0.65

0.65

0.65

0.65

0.65

0.65

$1,009,152

$807,322

$645,857

$516,686

$413,349

$330,679

$264,543

504,576

403,661

322,929

258,343

206,674

165,339

132,272

109,325

87,460

69,968

55,974

44,779

35,824

28,659

149,880

107,160

107,160

107,160

53,400

—

—

245,371

209,041

145,801

95,209

108,495

129,516

103,613

(98,148)

(83,616)

(58,320)

(38,083)

(43,398)

(51,806)

(41,445)

147,223

125,425

87,480

57,125

65,097

77,710

62,168

149,880

107,160

107,160

107,160

53,400

—

—

145,000

$ 297,103

$232,585

$194,640

$164,285

$118,497

$ 77,710

$207,168