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Permian Partners (PP) produces from aging oil fields in west Texas. Production is 1.97 million barrels per year in 2016, but production is declining at 9% per year for the foreseeable future. Costs of production, transportation, and administration add up to $26.70 per barrel. The average oil price was $66.70 per barrel in 2016.
PP has 8.7 million shares outstanding. The cost of capital is 11%. All of PP’s net income is distributed as dividends. For simplicity, assume that the company will stay in business forever and that costs per barrel are constant at $26.70. Also, ignore taxes.
a. Assume that oil prices are expected to fall to $61.70 per barrel in 2017, $56.70 per barrel in 2018, and $51.70 per barrel in 2019. After 2019, assume a long-term trend of oil-price increases at 7% per year. What is the ending 2016 value of one PP share?
Share Value=
b-1. What is PP’s EPS/P ratio?
b-2. Is it equal to the 11% cost of capital?
Yes or no
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