Petroleum Department Third Stage Petroleum Economics Economic Evaluation Indicators Economic Indicators (indicators describing project key characteristics) 1. NPV (Net Present Value) Rate of Return (ROR) or IRR (Internal Rate of Return) Payback Time Maximal Exposure Discounted Profitability Index (DPI) oR wn > NPV (Net Present Value) NPV = Present Value of the sum of all future cash flows Where: DR = discount rate ] = discounting period L = life of project a) Accept all projects with NPV > 0 ( positive value ) b) Drop all projects with NPV <0 (negative value ) c) If NPV =0, we are indifferent between accepting or dropping the project. > IRR (Internal Rate of Return) The rate of return (ROR) or internal rate of return (IRR) is the single discount rate that produces a NPV of zero. It is also described as the discount rate that equates the present worth of cash flows to be equal to the present worth of the investments. IRR = Discount Rate for which NPV = 0 Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics a) Accept all project with IRR > discount factor b) Drop all project with IRR < discount factor c) IFIRR = discount factor we are indifferent N:= Positive net present value No= Negative net present value m= Discount rate with positive net present value t2= Discount rate with negative net present value Discount Rate Graphical Internal Rate of Return > Maximal Exposure Max. Exp. = Minimum Value of the Discounted Cumulative Net Cash Flow Max. Exp. represents the capital needed for the project. Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Os > Discounted Profitability Index (DPI) This indicator is a measure of investment efficiency, and is used to evaluate multiple rates of return projects relative to the investment requirements. Consistent use of the same discount rate is necessary when comparing projects by using DPI. This indicator is sometimes called PI. DPI = (Net Present Value + Capital) / Capital Sometimes also expressed as DPI= NPV / Sum CAPEX (>0) Project ok if DPI > 1 > Payback Time or Payout Time Payback Time= Time at which the Cumulative Net Cash Flow becomes positives. Essentially the time required to get the investment back. OR Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics The point in time at which the cumulative net revenues equal the total of investment. Cetera poe Calculated as: Payback Time = Cost of Projects ‘Annual Cash Inflows eae Pho Ex: A project involves an immediate outlay of $25,000, with annual expenditures in each of three years of $4000, and generates revenue in each of three years of $15,000. These cash flows data may be set out, and annual net cash flows derived, as in Table below. Calculate NPV, IRR, PBT, DPI or Pl. Cumulative Year Revenue Capital Operating | Net Cash ae ee PV of Net ($) Outlays ($) | Costs ($) | Flow ($) ($) ara ojo 25000 _| 2000 | -27000 | __-27000 -27000_| 1 15000 0 4000 11000 || 10185.18519 | -16814.8148 2 15000 0 4000 11000 || 9430.727023 | -7384.08779 3 15000 0 2000 13000 || 10319.81913 | 2935.731342 IRR=14% | NPV=2935.73 I | PI=0.11 Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics NPV (s) & NCF ($) Time (year) em ($) NPV me(S) NCF EX: Calculation of (NPV, IRR, DPI&POT). Discounted eee ean Discount Cash Flow or PV @10% Ee Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Ld NPV & cF(S) Time (year) =e (8) NPV =m ($) Cash Flow EX: Calculation of (NPV, IRR, DPI&POT). Net Discounted Year| Revenue } cAPEX| oPEX] cash} CUMMS | Discount | NETCash J pacountedcUM (8) J ams) J as) | iow | °°," | Factor @1z% | Flow or py | NET ne Te ®) @10% 7 [0 | -20 | __20__| osecesriaa | i7esr1a2 “785714 jo | -20 | [ 255 | 145 J 071178004 | 18.1608008 | -16.65002128 25.5 ‘1 0.63551807, l 16.205711 I 0,555089768 a 30479473i7 x [sen |r fo secer002_ fs nae 11.9 08 121.8 0,32197323 0,25757858 52.64300577 40 J -40.3 J 121. 52.6430057 Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics 1- NPV = 52.64300577 2- IRR = 47 % 3- Payback time=3.5 yr. Lecture3 8/12/2016