Permian Partners (PP) produces from aging oil fields in west Texas. Production is 1.8 million barrels per year in 2009, but production is declining at 7% per year for the foreseeable future. Costs of production, transportation, and administration add up to $25 per barrel. The average oil price was $65 per barrel in 2009.
PP has 7 million shares outstanding. The cost of capital is 9%. All of PP’s net income is distributed as dividends. For simplicity, assume that the company will stay in business forever and that costs per barrel are constant at $25. Also, ignore taxes.
a. What is the PV of a PP share? Assume that oil prices are expected to fall to $60 per barrel in 2010, $55 per barrel in 2011, and $50 per barrel in 2012. After 2012, assume a long-term trend of oil-price increases at 5% per year.
b. What is PP’s EPS/P ratio and why is it not equal to the 9% cost of capital?
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