Question 1 - An investment related to developing a new product is estimated to have the following costs and revenues in "todays" or "time zero" dollars.
A) Evaluate the project escalated dollar ROR if both capital costs and operating costs are estimated to escalate at 15% per year from time zero with income escalating at 10% per year.
B) Make constant dollar ROR Analysis of Case "A" assuming the rate of inflation for the next 5 years will be 10% per year.
C) Use escalated dollar ROR Analysis to analyze the investment assuming a washout of escalation of income and operating costs with a 15% escalation of capital costs in year one.
Question 2 - An investor has an opportunity to buy a parcel of land for $200,000. He plans to sell it in two years. What will the land sale price have to be for the investor to get a 20% constant dollar before-tax ROR with inflation averaging 8% annually? What escalated dollar annual rate of increase in land value will give the needed sale price?
Question 3 - A petroleum project involves production of crude oil from a 5,000,000 barrel reserve. Time zero mineral rights acquisition cost (lease bonus) of $2,000,000 is the basis for cost depletion. Intangible drilling expenses of $1,500,000 will be incurred in time zero. Tangible producing equipment costing $3,000,000 at time zero will go into service in year one and be depreciated using the 7 year life Modified Accelerated Cost Recovery System (MACRS) depreciation with the half-year convention (the half-year convention included in the Table attached), beginning in year one. Production is estimated to be 350,000 barrels per year, starting in year one. Well- head crude oil value before transportation costs is estimated to be $42.00 per barrel in year one, $43.00 per barrel in year two, and $44.00 per barrel in year three. Royalties are 10.0% of revenues (well-head value) each year. Operating costs are expected to be $3,000,000 in year one, $3,300,000 in year two, and $3,600,000 in year three. The allowable percentage depletion rate is 15.0%. The effective income tax rate is 40.0%. No other income exists against which to use deductions, so all negative taxable income will be carried forward until used against project income (stand alone analysis). Determine the cash flows for years 0, 1, 2 and 3, without taking write-offs on remaining tax book values at year 3, assuming:
A) The investor is an integrated producer. Expense 70% of intangible drilling costs in time zero. Capitalize and deduct the other 30% by straight line amortization over 60 months assuming a six month deduction (6/60) in time zero. Only cost depletion may be taken by integrated producers.
B) The investor is an independent producer with less than 1,000 barrels per day average production. Expense 100% of intangible drilling costs in time zero; the larger percentage (subject to the 100% limit) and cost depletion is allowed on production up to 1,000 barrels per day. To simplify the calculations, assume all production would qualify for percentage depletion.
C) The investor is an independent producer with more than 1,000 barrels per day. Expense 100% of intangible drilling costs in time zero; only costs depletion is allowed on incremental production above 1,000 barrels per day.