Mw Petroleum

Discounted Cash Flow Valuation of Aggregate Reserves Discounted Cash Flow Valuation – Proved Developed Reserves Discounted Cash Flow Valuation – Proved Undeveloped Reserves Discounted Cash Flow Valuation – Probable Reserves Discounted Cash Flow Valuation – Possible Reserves Question 3 To value MW Petroleum we would consider the assets in place and the option bearing assets discretely. The assets in place consist of the proved developed reserves since they are already producing a determinable quantity of oil and natural gas, as well as the non-producing assets as if developed immediately (valued as the NPV of free cash flows).
The expenditures associated with the proved developed reserves are also known with some certainty since they consist primarily of maintenance and replacement costs that follow experience based norms. The NPV is subject to commodity price risk due to volatility in oil and gas prices, as well as uncertainty regarding the discount rate. The options consist of the delay in developing proved undeveloped, probable and possible reserves. In the case of these assets, significant development costs must be incurred to monetize the reserves.
In the case of the probable and possible reserves, the estimated cash flows are already risk weighted to account for the uncertainty in producible reserves. The options on these reserves are timing options. By incorporating volatility in commodity prices over time, Apache can value the ability to postpone capital expenditures to develop the reserves until volatility in commodity prices returns to historical levels. It is important that Apache have some level of certainty regarding minimum likely commodity prices over time since these are long-lived projects.

These options yield a higher value than the DCF valuation (of the aggregate cash flows). Since we are considering these reserves as potential projects in years five through seven, we use the Black-Scholes model to value the options. The option values are inclusive of the project, i. e. not just the option alone. Question 4: The assets underlying the options are quite risky as demonstrated by the rising volatility presented in the case.
Since Apache was primarily concerned with the oil assets, we used the highest recent oil price volatility of 50%. Since volatility is such a driver of option value, we also performed a sensitivity analysis to evaluate how the projects plus options would be valued at different revenue levels as well as with differing volatility. Question 5 Based on the value of all the call options derived in question 4, if the sale goes through then Apache Corporation would not exercise any of the options early.
In doing so, they would incur significant financial hardship while bearing the risk of highly volatile underlying assets. Given the potential financial strain of this acquisition, as incorporated by the cost of capital, Apache would benefit from observing prices develop over time. Our answer is based on the volatility which is assumed at 50%. Based on the sensitivity analysis it does not appear Apache would attempt to develop the possible reserves within the 5-7 year timeframe.