1.A petroleum company wants you to evaluate the economics of abandoning a stripp
ID: 2652443 • Letter: 1
Question
1.A petroleum company wants you to evaluate the economics of abandoning a stripper oil well versus selling the well to an interested investor. If the well is abandoned, a $25,000 abandonment cost must be incurred now (year 0) and a salvage value of $40,000 will be realized on the used producing equipment. $7,500 of book value remains on the producing equipment and will be written-off against the salvage value or other income at year 0 if the well is sold or abandoned. Assume other income exists against which to use deductions. The effective ordinary income tax rate is assumed to be 40%. Calculate the stripper well selling price that will make the economics of selling at year 0 a break-even with abandonment at year 0.
A) 13,000
B) 15,000
C) 12,000
D) 14,000
Explanation / Answer
1)proceeds on sale of producing equipment = 40000 - 13000**
= $ 27,000
cost net of tax shield = 25000 ( 1-.40 ) = 15,000
Net benefit = 27000 -15,000
= $ 12000
correct option is "C"
**capital gain tax =(40000-7500) *40%
= 32500*40%
= $ 13,000
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