Present value

The discounting process enables the conversion of any sum of money involved in the project to its present value (PV) at the point of comparison. (Confusingly, present does not necessarily mean now , 

Choice of the day of start-up as the comparison thus requires the acceptance that the present is actually some time in the future, and it employs two kinds of discounting (although one is only the reciprocal of the other). The fact that at start-up all expenditures are past, and that all income is in the future, eliminates the need to use negative cash flows, and is a slightly easier concept to grasp. It is also easier to manage construction periods that are not a whole number of years in this way. 

The method of calculation is based on transferring the value of money forward or backwards in time, by discounting. 

The present value PV of a sum S invested in the past, at an interest rate //100 per period, after n such periods is 

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After the first year, the future worth F of the capital cost present value P is given by... 

Net present value (NPV). Since money can be invested to earn interest, money received now has a greater present value than money received at some time in the future. The net present value of a project is the sum of the present values of each individual cash flow. In this case, the present is taken to be the start of a project. 

The sum of the annual discounted cash flows over n years SAdcf is known as the net present value (NPV) of the project ... 

Appraisal activity, if performed, is the step in the field life cycle between the discovery of a hydrocarbon accumulation and its development. The role of appraisal is to provide cost-effective information with which the subsequent decision can be made. Cost effective means that the value of the decision with the appraisal information is greater than the value of the decision without the information. If the appraisal activity does not add more value than its cost, then it is not worth doing. This can be represented by a simple flow diagram, in which the cost of appraisal is A, the profit (net present value) of the development with the appraisal information is (D2-A), and the profit of the development without the appraisal information is D1. 

Figure 7.1 Net present value with and without appraisal...

The type of development, type and number of development wells, recovery factor and production profile are all inter-linked. Their dependency may be estimated using the above approach, but lends itself to the techniques of reservoir simulation introduced in Section 8.4. There is never an obvious single development plan for a field, and the optimum plan also involves the cost of the surface facilities required. The decision as to which development plan is the best is usually based on the economic criterion of profitability. Figure 9.1 represents a series of calculations, aimed at determining the optimum development plan (the one with the highest net present value, as defined in Section 13). 

Keywords economic model, shareholder s profit, project cashflow, gross revenue, discounted cashflow, opex, capex, technical cost, tax, royalty, oil price, marker crude, capital allowance, discount rate, profitability indicators, net present value, rate of return, screening, ranking, expected monetary value, exploration decision making. 

What we have calculated is the present value (at a particular reference date) of a future sum of money, using a specified discount rate. In any discounting calculation, it is important to quote the reference date and the discount rate. 

Once the concept of discounting is accepted, the procedure becomes mechanical. The general formula for discounting a flow of money cooccurring in tyears time to its present value Cq assuming a discount rate r is... 

The cashflow discussed in Section 13.2 did not take account of the time value of money, and was therefore an undiscounted cashflow. The discounting technique discussed can now be applied to this cashflow to determine the present value of each annual cashflow at a specified reference date. 

The total undiscounted cash surplus (the ultimate cash surplus) is 190 m. The total discounted cash surplus ( 24.8 m) is called the net present value (NPV) of the project. Since in this example the discount rate applied is 20%, this figure would be the 20% NPV also annotated NPV(20). This is the present value at the beginning of Year 1 of the total project, assuming a 20% discount rate. 

At a specific discount rate the net present value (NPV) is reduced to zero. This discount rate is called the internal rate of return (IRR). 

One way of calculating the IRR is to plot the NPV against discount rate, and to extrapolate/ interpolate to estimate the discount rate at which the NPV becomes zero, as in the Present Value Profile in Figure 13.16. The alternative method of calculating IRR is by... 

Artificial lift techniques are discussed in Section 9.6. During production, the operating conditions of any artificial lift technique will be optimised with the objective of maximising production. For example, the optimum gas-liquid ratio will be applied for gas lifting, possibly using computer assisted operations (CAO) as discussed in Section 11.2. Artificial lift may not be installed from the beginning of a development, but at the point where the natural drive energy of the reservoir has reduced. The implementation of artificial lift will be justified, like any other incremental project, on the basis of a positive net present value (see Section 13.4). 

Wells are worked over to increase production, reduce operating cost or reinstate their technical integrity. In terms of economics alone (neglecting safety aspects) a workover can be justified if the net present value of the workover activity is positive (and assuming no other constraints exist). The appropriate discount rate is the company s cost of capital. 

Alfrey assigned styrene an e value of-1.0, but this was revised to the present value, which gives better agreement with experimental reactivity ratios. 

Fig. 1. Effect of energy use on total cost where total cost is the sum of capital and energy costs for the lifetime of the plant, discounted to present value. Point D corresponds to the design point if the designer uses an energy price that is low by a factor of four in projected energy price. Effects on costs of (a) pressure drop in piping, (b) pressure drop in exchangers, (c) heat loss through insulation, (d) reflux use, and (e) energy recovery through waste-heat boiler...

For any industrial process involving vapors and Hquids, the most important physical property is the vapor pressure. Table 1 presents values for the constants for a vapor-pressure equation and the temperature range over which the equation is vaHd for each butylene. 

Net Present Va.Iue, Each of the net annual cash flows can be discounted to the present time using a discount factor for the number of years involved. The discounted flows are then all at the same time point and can be combined. The sum of these discounted net flows is called the net present value (NPV), a popular profit criterion. Because the discounted positive flows first offset the negative investment flows in the NPV summation, the investment capital is recovered if the NPV is greater than zero. This early recovery of the investment does not correspond to typical capital recovery patterns, but gives a conservative and systematic assumption for investment recovery. 

The NPV represents the present-value net return, because provision has been made for capital recovery and the cost of capital. In other words, the NPV is a discounted net return or profit, analogous to the net return of the example introduced earher. 

The relationships among the various annual costs given by Eqs. (9-1) through (9-9) are illustrated diagrammaticaUy in Fig. 9-1. The top half of the diagram shows the tools of the accountant the bottom half, those of the engineer. The net annual cash flow Acp, which excludes any provision for balance-sheet depreciation Abd, is used in two of the more modern methods of profitability assessment the net-present-value (NPV) method and the discounted-cash-flow-rate-of-return (DCFRR) method. In both methods, depreciation is inherently taken care of by calculations which include capital recoveiy. 

FIG. 9-1 Relationship between annual costs, annual profits, and cash flows for a project. A d — annual depreciation allowance Acf — annual net cash flow after tax Ac/ = annual cash income Age = annual general expense Aqp = annual gross profit A/r = annual tax A e = annual manufacturing cost Avc/ = annual net cash income Avvp = annual net profit after taxes A/ p = annual net profit As = annual sales Apc = annual total cost (DCFRR) = discoiinted-cash-flow rate of return (NPV) = net present value. 

The ways of assessing profitabihty to be considered in this section are (1) discounted-cash-flow rate of return (DCFRR), (2) net present value (NPV) based on a particiilar discount rate, (3) eqmvalent maximum investment period (EMIP), (4) interest-recovery period (IRP), and (5) discounted breakeven point (DEEP). 

Discounted Cash Flow The present value P of a future sum of money F is given by... 

Example 2 Net Present Value for Different Depreciation Methods The following data descrihe a project. Revenue from annual sales and the total annual expense over a 10-year period are given in the first three columns of Table 9-5. The fixed-capital investment Cpc is 1,000,000. Plant items have a zero salvage value. Working capital C vc is 90,000, and cost of land C/ is 10,000. There are no tax allowances other than depreciation i.e., is zero. The fractional tax rate t is 0.50. 

The net present value (NPV) is found hy summing the values of Adcf for each year, as in Eq. (9-53). The net present value is found to he 276,210, as given hy the final entry in Table 9-5. 

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