Abstract
Projects and growth initiatives are crucial for an ENERGY COMPANY. Due to the character of finite resources on a project basis, especially in upstream value chain element (each reservoir will be depleted at one stage in time, and the reserves have to be replaced on a continuous basis), single investment decisions represent the bricks of a solid and sustainable Value Management in practice. Each adequately taken investment decision will be a further contribution to an economic and profitable portfolio.
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- 1.
One example for the definition of contingency levels can be found in Crundwell (2008).
- 2.
The sign ‘^’represents the following: for example, the expression 10^−1 is equal to the expression 10−1.
- 3.
Another example calculation: three project years. The annual inflation is assumed 2.50% for year 1, 3.00% for year 2 and 3.50% for year 3. The inflation multiplier for the first year equals (1 + 2.50%) = 1.0250. The inflation multiplier for the second year is derived by multiplying the inflation multiplier of the first year with (1 + 3.00%) which leads to 1.0558. The inflation multiplier for the third year is the inflation multiplier of the second year (i.e. 1.0558) multiplied with (1 + 3.50%) which amounts to 1.0927.
- 4.
The demonstrated ‘principle of additivity’ of the NPV is the basis for the so-called ‘sum-of-the-part’ valuation technique. Sum-of-the-part valuations take the different parts of the valuation target (e.g. the different business segments of a company) and apply different discount rates to reflect the various risk profiles of the different parts. In the end, the sum-of-the-part valuation aggregates the NPVs of all parts and delivers the total value of the valuation target.
In practice, instead of calculating the average discount rate for the calculation of the aggregated NPV (as in the example), a discount rate representing the weighted average of the cost of capital of the various parts, etc. could be applied to calculate the aggregated NPV.
- 5.
The additivity of the NPVs described here forms as a principle the basis for the so-called sum-of-the-part valuation. Please see Sect. 5.4.
- 6.
Please see also Sect. 5.6.1.1.1.
- 7.
In this book, the discount factors and inflation rates are annual discount factors and annual inflation rates (as opposed to monthly or quarterly rates).
- 8.
For explanation of the guess value, please check the Sect. 4.6.3 regarding Internal Rate of Return .
- 9.
‘Inside big companies there is a wide range of managers, board members and many others from various disciplines who need to be familiar with project economics. Therefore the financial evaluation technique needs to be simple and applicable among all companies. The DCF method meets these two requirements and remains the technique used by 99% of oil companies’.
- 10.
The formula does also take into account the respective discounting convention. Please see the example for the calculation of the (discounted) payback period in a business case on the next page. As the calculation of the payback period does only take into account the cash flow profile, the discounting convention will not have an influence on the payback period result. For example, if the mid-year discounting convention is used, the cash flow date is changing of the first point in time when a cash flow occurs. Consequently, also all other cash flows will be shifted to mid-year, and therefore the payback period will be the same as if the end-year discounting convention would have been used.
The factor which makes a difference is the point in time where the measurement of the payback period shall start: In this book, the payback period is starts from the point in time when the first cash flow occurs. Alternatively, the payback period could also be measured from the first day of the project or from the valuation date (which must not be necessarily the same date when the first cash flow occurs).
- 11.
There are cases in literature and practice that in the profitability index formula the value of 1 is added (DPI = NPV divided by PV CAPEX + 1). If the value of 1 is added in the formula and the DPI is >1, the project/investment is generating value (i.e. a positive NPV). In this chapter, the formula of the DPI does not use this addition of the value of 1. If the DPI, calculated with the formula which is discussed in this chapter, results to a number which is greater than zero, the project/investment generates value (i.e. a positive NPV). Reference is also made to Crundwell (2008).
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Schwarzbichler, M., Steiner, C., Turnheim, D. (2018). Single Investment Decision. In: Financial Steering . Springer, Cham. https://doi.org/10.1007/978-3-319-75762-9_4
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