FINC2012 Semester 2 2024 Individual Assignment
Due 13th September 2024
(Maximum word limit: 1,500 words)
This is an individual assignment. This means that you are required to write your own answers
to the questions. The Turnitin system checks for any copied work
The Operations Department at PetroDynamics oversees all company activities related to
gathering, purchasing, processing, and selling of oil. You are a recent graduate who was
recently hired as a financial analyst to support the department. One of your tasks is to review
the projections for a proposed ten-year oil purchase project created by one of the firm's field
engineers. The ten-year project’s cash flow projections are based on the following assumptions
and estimates:
• The required initial capital expenditure for the project involves a $20 million cost to lay
a new oil pipeline. The project is expected to be fully depreciated on a straight-line
basis over its ten-year lifetime. The project is assumed to have no salvage value at the
end of its life.
• The project requires an investment of $1,250,000 in net working capital at the project’s
inception. This is assumed to be fully recovered at the end of the project.
• The oil well is expected to produce 1,000 barrels of oil per day in the first year, with
production declining over the following nine years. The oil production is expected to
decrease by 15% each year after the first year.
• A fee consisting of 60% of the wellhead oil market price must be paid to the oil
producer. For example, if the wellhead market price is $100 per barrel, 60% ($60) is
paid to the oil producer. This percentage is expected to remain constant over the life of
the project.
• Other operational variable costs of $8.50 per barrel will be incurred in the project. These
are also expected to be constant over the life of the project.
• The current oil price at the wellhead is $80 per barrel and is assumed to remain at this
level over the entirety of the project’s life.
• The project's cost of capital is 12%.
• The corporate tax rate is 35%.
• All dollar magnitudes are in nominal amounts.
Task 1 (5 marks): Based on the information and forecasts above, calculate the NPV and IRR
for the proposed project. Should the project be adopted? Explain your answer. What
reservations, if any, would you have about recommending the adoption of the project to your
immediate Senior Manager? Justify your response.
Task 2 (4 marks): Perform and report the results of a sensitivity analysis seeking to determine
which factors most significantly impact the NPV of the proposed project. Justify your answer
as well as all of the assumptions underlying your analysis.
Task 3 (3 marks): Undertake and report the results of “breakeven analysis” on the proposed
project’s key factors (or ‘value drivers’) underpinning its NPV.
Task 4 (6 marks): You have been informed that three alternative scenarios are also being
considered for the oil pipeline investment project. These are outlined in the table below.
Possible Scenarios Being Considered
Scenario 1:
Renewable Energy
Acceleration Scenario
Scenario 2
Geopolitical Instability
Scenario
Scenario 3
Environmental Policy
Tightening Scenario
Accelerated investment in
renewable energy, coupled
with breakthroughs in energy
storage and distribution, leads
to a rapid shift away from
fossil fuels.
▪ A significant reduction in
demand for oil due to the
rapid adoption of renewable
energy alternatives.
▪ Lower volumes of oil flowing
through the pipeline reduce
operational efficiency and
increase per-unit
transportation costs.
▪ Governments impose
additional taxes and
restrictions on fossil fuel
infrastructure to further
incentivize the transition to
renewables
Rising geopolitical tensions in
key oil-producing regions lead
to supply disruptions and
uncertainty in global oil
markets.
▪ Disruptions in supply chains
cause a sharp increase in oil
prices, boosting potential
revenue for the pipeline.
▪ Increased risk and
uncertainty lead to higher
materials costs and
insurance.
▪ Geopolitical instability could
lead to disruptions in
operations, reducing overall
operational efficiency.
Governments worldwide
implement stricter
environmental policies to
combat climate change,
leading to increased
regulatory burdens on fossil
fuel infrastructure projects.
• Reduced demand for fossil
fuels because of a stronger
push for renewable energy
alternatives.
• Increased complexity and
compliance requirements
reduce overall operational
efficiency.
• Significant increase in
compliance costs due to
stricter environmental
standards.
While specific estimates and values for key variables within each scenario have not yet been
finalized, a close colleague has proposed some preliminary figures that may be relevant. These
preliminary estimates are summarized in the second table below.
Scenario 1:
Renewable Energy
Acceleration Scenario
Scenario 2
Geopolitical Instability
Scenario
Scenario 3
Environmental Policy
Tightening Scenario
• Oil price at the wellhead is
$40 per barrel and constant
over the life of the project.
•
Year 1 volume of 800 barrels
of oil per day that declines
by 15% each year after that.
• Other operational variable
costs increase to $10.50 per
barrel and are constant over
the life of the project.
•
New regulatory compliance
costs of an additional $5.50
per barrel and are constant
over the life of the project.
• Oil price at the wellhead is
$120 per barrel and constant
over the life of the project.
• Year 1 volume of 1100
barrels of oil per day that
declines by 10% each year
after that.
• Other operational variable
costs increase to $10.00 per
barrel and are constant over
the life of the project.
• Oil price at the wellhead is
$65 per barrel and constant
over the life of the project.
• Year 1 volume of 900 barrels
of oil per day that declines
by 15% each year after that.
• Other operational variable
costs increase to $11.00 per
barrel and are constant over
the life of the project.
• Additional environmental
standard compliance costs of
$9.00 per barrel and are
constant over the life of the
project.
Although your colleague’s assessments provide a useful starting point, you may wish to amend,
modify, or extend these estimates to develop your own values for the key variables across the
three scenarios.
As an additional element of your project analysis, undertake and report the results of scenario
analysis utilising your own estimates and values of key variables across the three scenarios.
Specifically, assess the NPV under each of the three scenarios. Ensure that you provide a clear
and well-supported justification for the estimates and values you choose for each scenario.
Task 5 (7 marks): Write a clear and concise professional memo to your senior manager,
summarising the results and conclusions of your project analysis as covered in Tasks 1, 2, 3
and 4. The memo should contain no more than one-page of text (single spaced, 12-point font)
followed by at most with one additional page of supporting tables, figures etc. Include bullet
points where appropriate and utilize bold and non-bold fonts to emphasize key points. Given
that your Senior Manager reviews around twenty such memos daily, it is crucial that your
communication is both clear and to the point. Aim to present the analysis in a way that
facilitates quick comprehension of the key findings and their implications.
Note: The document containing your answers to Tasks 1 to 5 inclusive, as well as all Excel
spreadsheet files supporting your analysis must be submitted.
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