Question

Mini Case Study

An oil company is considering changing the size of a small pump that is currently operational in wells in an oil field. If this pump is kept, it will extract 50% of the known crude-oil reserve in the first year of its operation and the remaining 50% in the second year. A pump larger than the current pump will cost $1.6 million, but it will extract 100% of the known reserve in the first year. The total oil revenues over the two years are the same for both pumps, namely, $20 million. The advantage of the large pump is that it allows 50% of the revenues to be realized a year earlier than with the small pump.

If the firm’s MARR is known to be 20%, what do you recommend based on the IRR criterion? Confirm your answer using PW analysis.

	Current pump	Larger pump
Investment, year 0	0	$1.6 million
Revenue, year 1	$10 million	$20 million
Revenue, year 2	$10 million	0

Mini Case Study Rubric

1. Analysis: Apply the SEAT to conduct an engineering economic analysis to the case study in addition to using the economic measures specified in the case study.
2. Conclusion: this section should include the decision based on the analysis conducted in the previous section.

Answer 1

Answer:

The first thing to do here is to create a table within Microsoft Excel in order to get the required rate(s) of return for the situation at hand. Then apply the formula IRR(value1..value n) to get the results as below Net Cash Flow for provided models Current Pump Larger Pump Year (N) ? (B-A) (A) (B) ($1,600,000.00) |($1,600,000.00) $0.00 $10,000,000.00 $20,000,000.00 $10,000,000.00 1 $10,000,000.00 $0.00 ($10,000,000.00) 2 25% IRR #NUM! 1,150%

Thus, from what one can see here, there is an incremental analysis that would need to be done in order to get the proper answer. Since the value of IRR is a number well above the required MARR, it is recommended to go with the larger pump