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Calld dyer e 10/29/19 8:58 AM Homework: Homework 6 Save Score: 0 of 10 pts 14 of 18 (14 complete) HW Score: 66.07%, 118.92 of 180 pts P11-23 (similar to) Question Help (Payback period and NPV calculations) Plato Energy is an oil and gas exploration and development company located in Farmington, New Mexico. The company drills shallow wells in hopes of finding significant and gas deposits. The firm is considering two different drilling opportunities that have very different production potentials. The first is in the Barnett Shale region of central Texas and the other is in the Gulf Coast. The Barnett Shale project requires a much larger initial investment but provides cash flows (if successful) over a much longer period of time than the Gulf Coast opportunity. In addition, the longer life of the Barnett Shale project also results in additional expenditures in year 3 of the project to enhance production throughout the project's 10-year expected life. This expenditure involves pumping either water or CO, down into the wells in order to increase the flow of oil and gas from the structure. The expected cash flows for the two projects are as follows: a. What is the payback period for each of the two projects? b. Based on the payback periods, which of the two projects appears to be the best alternative? What are the limitations of the payback period ranking? That is what does the payback period not consider that is important in determining the value creation potential of these two projects? c. If Plato's management uses a discount rate of 19.9 percent to evaluate the present values of its energy investment projects, what is the NPV of the two proposed investments? d. What is your estimate of the value that will be created for Plato by the acceptance of each of these two investments? a. Given the cash flow information in the table, the payback period of the Barnett Shale project is years. (Round to two decimal places.) Data Table Year Gulf Coast $(1,300,000) 825,000 825,000 350,000 140,000 OWN- Barnett Shale $(5,200,000) 2,080,000 2,080,000 (1.040,000) 2,000,000 1,680,000 1,680,000 1,680,000 800,000 400.000 80,000 Enter your answer in the answer box and then cli 7 Parts remaining ins Pgon Poup End Home End Presen Home ESC 8 9

Answer 1

Answer 1) Payback period is define as the time required to get back all investment from a project , i.e time required to be net cash flow equal to zero.

Year	Barnett Shale	Net cash flow	Gulf Coast	Net cash flow
0	-5200000		-1300000
1	2080000	-3120000	825000	-475000
2	2080000	-1040000	825000	350000
3	-1040000	-2080000	350000	0
4	2080000	0	140000
5	1680000
6	1680000
7	1680000
8	800000
9	400000
10	80000
	Payback period	4 years		3 years

Answer b.1 ) As per project selection criteria in Payback period , the project with low payback period should be given preference.

So , the gulf coast project should be selected with low payback period .

Answer b.2) Limitation of Payback period ranking :

• doesn't consider concept of the time value of money
• doesn't consider concept of the profitability in project
• doesn't consider cash flows generated after payback period in calculation

Answer b 3) Payback period doesn't consider cash flows generated after payback period in the calculation , as both the project have different tenure of execution.

Answered first four questions including sub-part as per policy , kindly re-post remaining questions