Changes

|-

|-

| NPV at 4%

| NPV at 4%

| [[cost::1 USD]],015,600

| [[cost::1,015,600 USD]]

|-

|-

| DCFROR (%)

| DCFROR (%)

|-

|-

| Cumulative undiscounted NCF (after-tax)

| Cumulative undiscounted NCF (after-tax)

| [[cost::1 USD]],201,893

| [[cost::1,201,893 USD]]

|-

|-

| Undiscounted payout (years)

| Undiscounted payout (years)

|-

|-

| Undiscounted profit to investment ratio

| Undiscounted profit to investment ratio

| [[cost::1 USD]],201,893/1,375,000 = 0.87

| [[cost::1,201,893 USD]]/1,375,000 = 0.87

|-

|-

| Investment efficiency (4% discount rate)

| Investment efficiency (4% discount rate)

| [[cost::1 USD]],015,600/1,375,000=0.74

| [[cost::1,015,600 USD]]/1,375,000=0.74

|-

|-

| Discounted profit to investment ratio (4% discount ratio)

| Discounted profit to investment ratio (4% discount ratio)

| [[cost::1 USD]],015,600/1,375,000=0.74

| [[cost::1,015,600 USD]]/1,375,000=0.74

|-

|-

| Expected net present value (4% discount rate) ''P''_s = 0.80, ''P''_f = 0.20

| Expected net present value (4% discount rate) ''P''_s = 0.80, ''P''_f = 0.20

| 0.80 × 1,015,600 – 0.20 × 495,000 = [[cost::713 USD]],480

| 0.80 × 1,015,600 – 0.20 × 495,000 = [[cost::713,480 USD]]

|}

|}

|-

|-

| NPV at 4%

| NPV at 4%

| [[cost::2 USD]],729,760

| [[cost::2,729,760 USD]]

|-

|-

| DCFROR (%)

| DCFROR (%)

|-

|-

| Cumulative undiscounted NCF (after-tax)

| Cumulative undiscounted NCF (after-tax)

| [[cost::3 USD]],634,721

| [[cost::3,634,721 USD]]

|-

|-

| Undiscounted payout (years)

| Undiscounted payout (years)

|-

|-

| Undiscounted profit to investment ratio

| Undiscounted profit to investment ratio

| [[cost::3 USD]],634,721/7,225,000 = 0.50

| [[cost::3,634,721 USD]]/7,225,000 = 0.50

|-

|-

| Investment efficiency (4% discount rate)

| Investment efficiency (4% discount rate)

| [[cost::2 USD]],729,760/2,429,333 = 1.12

| [[cost::2,729,760 USD]]/2,429,333 = 1.12

|-

|-

| Discounted profit to investment ratio (4% discount ratio)

| Discounted profit to investment ratio (4% discount ratio)

| [[cost::2 USD]],729,760/6,859,396 = 0.40

| [[cost::2,729,760 USD]]/6,859,396 = 0.40

|-

|-

| Expected net present value (4% discount rate) ''P''_s = 0.70, ''P''_f = 0.30

| Expected net present value (4% discount rate) ''P''_s = 0.70, ''P''_f = 0.30

| 0.70 × 2,729,760 – 0.30 × 990,000 = [[cost::1 USD]],613,832

| 0.70 × 2,729,760 – 0.30 × 990,000 = [[cost::1,613,832 USD]]

|}

|}

==Net present value==

==Net present value==

''Net present value'' (NPV), or net present worth, is based on the concept of equivalence discussed in the chapter on “The Time Value of Money.” The net present value is equivalent to the future cash flows at the assumed discount rate. It is the fundamental parameter to express value of a project ''assuming success'', and it measures the cumulative cash worth of the venture above the corporate discount rate. Ordinarily, it is based upon the ''mean reserves case''. For the development well in Table 1 of the chapter on “Building a Cash Flow Model,” the NPV at 4% = [[cost::1 USD]],015,600. For the extension project (see Table 3 of the same chapter), the NPV at 4% = [[cost::2 USD]],729,760.

''Net present value'' (NPV), or net present worth, is based on the concept of equivalence discussed in the chapter on “The Time Value of Money.” The net present value is equivalent to the future cash flows at the assumed discount rate. It is the fundamental parameter to express value of a project ''assuming success'', and it measures the cumulative cash worth of the venture above the corporate discount rate. Ordinarily, it is based upon the ''mean reserves case''. For the development well in Table 1 of the chapter on “Building a Cash Flow Model,” the NPV at 4% = [[cost::1,015,600 USD]]. For the extension project (see Table 3 of the same chapter), the NPV at 4% = [[cost::2,729,760 USD]].

{| class = "wikitable"

{| class = "wikitable"

==Maximum negative cash flow==

==Maximum negative cash flow==

''Maximum negative cash flow'' (MNCF) is an important measure because it expresses the greatest ''cumulative'' out-of-pocket expense—that is, the greatest cash “exposure” in any project—and thus is useful in budgeting, planning, and project comparison in firms that are cash constrained. It is derived from the cash flow model by expressing the net of investments and costs against early revenues. Thus, it is the turnaround spot on the cumulative net cash flow stream. It is not a discounted number. The undiscounted MNCF for the extension project is [[cost::2 USD]],471,507, as shown in Figure 2 (see Table 3 in the chapter on “Building a Cash Flow Model”).

''Maximum negative cash flow'' (MNCF) is an important measure because it expresses the greatest ''cumulative'' out-of-pocket expense—that is, the greatest cash “exposure” in any project—and thus is useful in budgeting, planning, and project comparison in firms that are cash constrained. It is derived from the cash flow model by expressing the net of investments and costs against early revenues. Thus, it is the turnaround spot on the cumulative net cash flow stream. It is not a discounted number. The undiscounted MNCF for the extension project is [[cost::2,471,507 USD]], as shown in Figure 2 (see Table 3 in the chapter on “Building a Cash Flow Model”).

Like payout, MNCF may be relatively more important to risk-averse smaller investors. It does not address chance of project success. For individual development wells, such as our example problem, MNCF is not particularly useful since there is rarely much overlap in time between capital expenses and production revenue.

Like payout, MNCF may be relatively more important to risk-averse smaller investors. It does not address chance of project success. For individual development wells, such as our example problem, MNCF is not particularly useful since there is rarely much overlap in time between capital expenses and production revenue.

''Undiscounted profit to investment ratio'' (P/I) measures the magnitude of cash flow with respect to investment, but it does not address the time frame in which the profits are received. Neither does it express the magnitude of the venture or any aspect of risk. ''Profit'' can be defined as the net operating income (NOI) or as the net cash flow (NCF). If profit is defined as NCF, the minimum acceptable ratio is 0.0, whereas if it is defined as NOI, the minimum acceptable ratio is 1.0. The difference between the two ratios for a project is always 1.0. If someone uses profit to investment ratios, ask them what their definition of profit is. Also, projects need to be ranked and compared on a consistent basis.

''Undiscounted profit to investment ratio'' (P/I) measures the magnitude of cash flow with respect to investment, but it does not address the time frame in which the profits are received. Neither does it express the magnitude of the venture or any aspect of risk. ''Profit'' can be defined as the net operating income (NOI) or as the net cash flow (NCF). If profit is defined as NCF, the minimum acceptable ratio is 0.0, whereas if it is defined as NOI, the minimum acceptable ratio is 1.0. The difference between the two ratios for a project is always 1.0. If someone uses profit to investment ratios, ask them what their definition of profit is. Also, projects need to be ranked and compared on a consistent basis.

The undiscounted profit to investment ratio (with profit as NCF) for the development well and the extension project in the chapter on “Building a Cash Flow Model” are [[cost::1 USD]],201,893/[[cost::1 USD]],375,000 = 0.87 and [[cost::3 USD]],634,721/[[cost::7 USD]],225,000 = 0.50, respectively.

The undiscounted profit to investment ratio (with profit as NCF) for the development well and the extension project in the chapter on “Building a Cash Flow Model” are [[cost::1,201,893 USD]]/[[cost::1,375,000 USD]] = 0.87 and [[cost::3,634,721 USD]]/[[cost::7,225,000 USD]] = 0.50, respectively.

==Investment efficiency==

==Investment efficiency==

Although these are highly recommended yardsticks, they do have some limitations since they do not express the magnitude of cash flows or the chance of success. Table 3 shows a simple example demonstrating the difference in the two economic yardsticks.

Although these are highly recommended yardsticks, they do have some limitations since they do not express the magnitude of cash flows or the chance of success. Table 3 shows a simple example demonstrating the difference in the two economic yardsticks.

The investment efficiency for our example development well is [[cost::1 USD]],015,600/[[cost::1 USD]],375,000 = 0.74, whereas the investment efficiency for the extension project is [[cost::2 USD]],729,760/[[cost::2 USD]],429,333 = 1.12. Both ratios are based on a 4% discount rate.

The investment efficiency for our example development well is [[cost::1,015,600 USD]]/[[cost::1,375,000 USD]] = 0.74, whereas the investment efficiency for the extension project is [[cost::2,729,760 USD]]/[[cost::2,429,333 USD]] = 1.12. Both ratios are based on a 4% discount rate.

==Expected net present value and enpv to expected investment ratio==

==Expected net present value and enpv to expected investment ratio==

The ENPV considers the net after-tax monetary value of the venture over the full life of the project (gross revenues minus capital investments and costs) discounted at the corporate discount rate. It incorporates current views on future wellhead prices, costs, and inflation rates and also takes into account the probabilities of success and failure as well as the cost of failure. Thus, it is a “risked” value and is the amount the company could expect to make on average if this prospect (or ones like it) could be undertaken many times.

The ENPV considers the net after-tax monetary value of the venture over the full life of the project (gross revenues minus capital investments and costs) discounted at the corporate discount rate. It incorporates current views on future wellhead prices, costs, and inflation rates and also takes into account the probabilities of success and failure as well as the cost of failure. Thus, it is a “risked” value and is the amount the company could expect to make on average if this prospect (or ones like it) could be undertaken many times.

If the development well modeled in Table 1 in the chapter on “Building a Cash Flow Model” had been assigned an 80% chance of success by the geologist, the calculated ENPV (aftertax) at 4% would be [[cost::713 USD]],480 (0.80 × [[cost::1 USD]],015,600 – 0.20 × [[cost::495 USD]],000). Since this is a linear function, a plot of ENPV versus the probability of success results in a straight line. Assume two points (''P''_s = 1 and 0) to define the line. The intersection where the ENPV is zero will give the breakover point for the probability of success. Figure 3 demonstrates this concept. The breakover probability of success for the development well is approximately 33%.

If the development well modeled in Table 1 in the chapter on “Building a Cash Flow Model” had been assigned an 80% chance of success by the geologist, the calculated ENPV (aftertax) at 4% would be [[cost::713,480 USD]] (0.80 × [[cost::1,015,600 USD]] – 0.20 × [[cost::495,000 USD]]). Since this is a linear function, a plot of ENPV versus the probability of success results in a straight line. Assume two points (''P''_s = 1 and 0) to define the line. The intersection where the ENPV is zero will give the breakover point for the probability of success. Figure 3 demonstrates this concept. The breakover probability of success for the development well is approximately 33%.

[[file:key-economic-parameters_fig3.png|thumb|{{figure number|3}}Expected value profile plot. Expected value is plotted versus probability of success example for development well and multiwell extension project.]]

[[file:key-economic-parameters_fig3.png|thumb|{{figure number|3}}Expected value profile plot. Expected value is plotted versus probability of success example for development well and multiwell extension project.]]

<fig id="KeyEconomicsufig1"><graphic mime-subtype="png" xlink:href="KeyEconomicsuFig1"></graphic></fig>If the extension project had been assigned a 70% chance of success by the geologist, the calculated ENPV (after-tax) at 4% would be [[cost::1 USD]],613,832 (0.70 × [[cost::2 USD]],729,760 – 0.30 × [[cost::990 USD]],000). The breakover probability of success for the extension project is approximately 27% (see Figure 3).

<fig id="KeyEconomicsufig1"><graphic mime-subtype="png" xlink:href="KeyEconomicsuFig1"></graphic></fig>If the extension project had been assigned a 70% chance of success by the geologist, the calculated ENPV (after-tax) at 4% would be [[cost::1,613,832 USD]] (0.70 × [[cost::2,729,760 USD]] – 0.30 × [[cost::990,000 USD]]). The breakover probability of success for the extension project is approximately 27% (see Figure 3).

The expected net present value is useful in comparing large or complex ventures, as well as projects having different discovery probabilities and reserves potential. The parameter is useful in prospect inventories and for program planning and budgeting if estimates of reserves and discovery probability are reliable. The expected net present value to expected investment ratio is also useful in capital investment decisions when capital is limited. Newendorp<ref name=pt02r13 />) demonstrates the use of this investment efficiency ratio.

The expected net present value is useful in comparing large or complex ventures, as well as projects having different discovery probabilities and reserves potential. The parameter is useful in prospect inventories and for program planning and budgeting if estimates of reserves and discovery probability are reliable. The expected net present value to expected investment ratio is also useful in capital investment decisions when capital is limited. Newendorp<ref name=pt02r13 />) demonstrates the use of this investment efficiency ratio.