Reference no: EM132761382
Question: Plato Energy is an oil and gas exploration and development company located in? Farmington, New Mexico. The company drills shallow wells in hopes of finding significant oil and gas deposits. The firm is considering two different drilling opportunities that have very different production potentials. The first is in the Barnett Shale region of central Texas and the other is in the Gulf Coast. The Barnett Shale project requires a much larger initial investment but provides cash flows? (if successful) over a much longer period of time than the Gulf Coast opportunity. In? addition, the longer life of the Barnett Shale project also results in additional expenditures in year 3 of the project to enhance production throughout the? project's 10-year expected life. This expenditure involves pumping either water or CO2 down into the wells in order to increase the flow of oil and gas from the structure. The expected cash flows for the two projects are as? follows:
Year Barnett Shale Gulf Coast
0 ?$(4,800,000?) ?$(1,300,000?)
1 1,920,000 900,000
2 1,920,000 900,000
3 ?(960,000?) 375,000
4 1,920,000 150,000
5 1,620,000
6 1,620,000
7 1,620,000
8 800,000
9 600,000
10 90,000
a. What is the payback period for each of the two? projects?
b. Based on the payback? periods, which of the two projects appears to be the best? alternative? What are the limitations of the payback period? ranking? That? is, what does the payback period not consider that is important in determining the value creation potential of these two? projects?
c. If? Plato's management uses a discount rate of 20.7 percent to evaluate the present values of its energy investment? projects, what is the NPV of the two proposed? investments?
d. What is your estimate of the value that will be created for Plato by the acceptance of each of these two? investments?
e. Given the cash flow information in the? table, the payback period of the Barnett Shale project is nothing years. ?(Round to two decimal? places.)
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