A company operating in a large oilfield produces a fixed amount of oil annually
A company operating in a large oilfield produces a fixed amount of oil annually. After the company has finished with an oil-well it commences to operate another well. The number of years each well is operated before being abandoned has been optimised on a minimum-cost criterion. That number of years is called a cycle and comparative costs are all calculated as the net present values for an infinite number of cycles in the future. This optimum cost is £13.5million
The company had been offered a long lease on a newly-discovered oilfield where the quality and quantities of oil are adequate for its commitments. The lease would cost £2.3million, payable after two years. The cost of moving from the existing site would be £700,000, payable immediately. The annual costs of operating each well in the new field, including maintenance and drilling costs, vary according to the number of years of use, as given in the table below. Costs apply at the end of the stated year in the cycle.
Operating Cost Table for new field:
Given that the rate of interest on money is 9% per annum:
a) Based on operating costs only, determine the length of the most economical cycle of operation for a well in the new field, costs being based on net present value for an infinite number of cycles.
b) Calculate, on a total cost basis in present terms), whether the company should move from the existing site. How much will the company lose/gain in moving to the new site?
Accounts & Finance"NPV stands for Net Present Value i.e.value of future money derived today being discounted at a specified discount rate based on certain market forces. Formula for calculating NPV for infinite number of time is NPV = Fv/i where i is the discount rate and FV is the future value.Operating cost is the cost incurred on day to day basis for maintaining the business and operat...