1. TXC Energy Distributors, a natural gas and gas products company, is analyzing

ID: 2786235 • Letter: 1

Question

1. TXC Energy Distributors, a natural gas and gas products company, is analyzing a gas purchase project. The projections were provided by a field engineer, and the project is expected to last 10 years. The company's cost of capital is 13%, and the projections from the field engineer's report are as follows: "The investment requires two components. The first is the cost to lay the natural gas pipeline. The equipment costs $1,100,000 and the installation is $100,000. The next cost is the $145,000 required increase in net working capital. The well is expected to produce 970,000 cubic feet (970 MCF) per day of natural gas during year 1 and then decline over the remaining nine-year period. The natural gas production is expected to decline by 20% per year after year 1, Note that we expect to operate 365 days per year assuming there are no maintenance shut downs. Along with the additional expenditures for the pipeline, the company has three additional sets of expenses. The first is a contracted fee consisting of 30% of the wellhead natural gas market price which must be paid to the producer (i.e., if the wellhead price is $3.00 per MCF, the fee is $0.90 MCF). In addition, gas compression and processing costs total $0.40 per MCF. The final cost is a fixed cost of $7,000 per year for insurance, etc. The equipment is expected to have a salvage value of around $30,000 after 10 years and working capital is expected to be 15% of annual revenue (and then working capital is recovered at project end). Also at project termination, there is expected to be reclamation costs of $15,000." A) (5 points) What is the initial outlay for this project? B) (5 points) What is the terminal value cash flow?

Explanation / Answer

Answer a.
The initial outlay for the project is FCinv + NWCinv
The equipment would cost $1,100,000 and installation would be $100,000
Thus FCinv = 1100000+100000 = 1,200,000
and WCinv increased by $145000
Hence,
The initial outlay for the project is FCinv + NWCinv
=1,200,000+145000
=1345,000

Answer B.
Terminal value cash flow = Salvage+NWCinv-Tax(Salvage-bookvalue)
Salvage given = 30000
And as projects in oil and gas industry needs cash outflow too for the reclamation cost, here it is 15000
Bookvalue and tax is not given and thus we assume to be zero
NWCinv would be 145,000 but this is in addition to the 15% of annual revenue thus annual revenue
Production in year which will decline by 20% yoy thus in year 10 production will be as shown below in the excel:

By using formula in year 2 as = Year 1*(1-20%) and similarly for year 3 as = year 2*(1-20%)

Years

Production

970000.00

776000.00

620800.00

496640.00

397312.00

317849.60

254279.68

203423.74

162739.00

130191.20

Terminal value cash flow = Salvage-reclamationcost+NWCinv-Tax*(Salvage-bookvalue)
=(30000-15000)+(145000+58586)-0*(30000-0)
=15000 + 203586 - 0
=218586