Introduction     Future Value     Present Value     Net Present Value I     Net Present Value II     Discount Rate   Expected NPV

   Decision Tree     Utility     Opportunity and Sunk Costs  Evaluating Oil Rights    Free Rider    Strategy

The example used in the previous section assumes that you will be the sole owner of a deep well. In OilFinancier rules, this will never happen: you must form a partnership to drill any well.

So a more realistic example may involve you being approached by three other financiers to drill a deep well. They propose that each financier contributes $75,000 for the drilling of the well and shares 15% of the revenue (the remaining 40% goes to the owner of the oil rights). Should you take this deal?

You should go back to your spreadsheet. In the table below, we are assuming a $75,000 capital investment, an initial cash flow of $3,600 per day ($24,000 x 0.15), and a discount rate as being 2.5%.

In this case, the NPV at 50 days is negative. From the size of the discounted cash flow at Day 50, it looks like you would need to extend the spreadsheet about another 20 days to see a positive NPV.

These numbers are telling you to stay away from this proposal. Perhaps the owner of the oil rights should look at reducing his take of the revenues to entice you into being a partner. Or perhaps the partnership should look at negotiating a subsequent deep well to make this deal work. If you believe your financial techniques are sound and you have the proper discount rate, don’t sacrifice them to make a deal. You are better off investing elsewhere in the seminar.

Knowing when to stay away from bad deals is a part of doing good business. I hope this attribute will be reinforced as part of your business instincts with this seminar.

Note the discount factor of the two examples at Day 50. In the first example, with a 1% discount rate, the discount factor was 0.61. In the 2.5% example, the discount factor was 0.29. This shows that the larger the discount rate, the harsher future cash flows are discounted. At higher discount rates, cash flows at Day 50 would have very little impact on the NPV calculation. I encourage you to experiment with your own spreadsheet to determine the relationships of discount rates and Net Present Value.

Copyright © - DAVE VOLEK PUBLISHING - All Rights Reserved
Contents cannot be reproduced in whole or in part, in any form, without the permission of the publisher
Site developed and managed by Gold Media Inc - Toll Free:  1-888-910-6800