MW PETRO

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MW PETRO

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assignment is worth a maximum of 100 points. 1. (10 points.) Apart

from any quantitative analysis, are there any reasons to anticipate that

Apache Corporations acquisition of MW Petroleum might be a positive

net present value activity for Apache, for Amoco? Explain. This looks

like an attractive deal for both parties. Amoco does many things well,

but managing smaller, marginally productive oil and gas fields

apparently isnt one of them. This is a chance to unload some

properties that because of their high cost structure, Amoco cant

manage profitably. Apache, on the other hand, has low costs and is an

efficient operator of small- to mediumsized properties. The company

has grown significantly in recent years by acquiring less wellrun

properties and applying its rationalize and reconfigure strategy. The

MW Petroleum properties appear to offer the opportunity to continue

this strategy. If Amoco can strike a price wherein Apache shares some

of its operating savings with Amoco, both parties can generate positive

net present values from the transaction. Acquisition of MW Petroleum

may also reduce the volatility of Apaches cash flows by making them

less dependent on gas. Although this may not benefit shareholders

directly, it will likely enable management to sleep better and might

increase Apaches borrowing capacity, thereby benefiting shareholders

indirectly. 2. (10 points.) Whose projections appear in the case

exhibits? From Apaches perspective, is there any reason to believe

these numbers might be biased one way or another? Does the value of

MW Petroleum derived from these numbers represent Apaches

maximum acquisition price? Explain. The story appears to be a mixed

one. Although Apache is capable of making its own cash flow

projections, the projections presented are not Apaches. In particular,

the oil and gas price forecasts were compiled by Morgan Stanley

(representing Amoco in the sale). The estimates of reserves and

annual production figures were generated by independent petroleum

engineers (presumably paid by Amoco). The forecasts of direct costs

are based primarily on Amocos historical experience, and projected

overhead is based on amounts Amoco itself expects to save by

divesting MW. Recall, the basic premise of the transaction is that

Apache can operate the fields more efficiently than Amoco. Because

such efficiencies have not yet been incorporated into the projections,

there is reason to believe the direct costs are overstated from Apaches

perspective. Looking only at the direct costs, their overstatement

suggests that the resulting valuation may be biased low. If so, the

valuation will be below Apaches maximum acquisition price, and

Apache could bid above this figure and still generate a positive NPV.

The valuation might be viewed more properly as Amocos reservation

price, below which it should not sell. 3. (20 points.) Exhibits 3-7 contain

cash flow projections for MW Petroleum. To what extent do these

numbers represent free cash flows suitable for use in a discounted

cash flow valuation? In particular, please comment on the treatment of

overhead (line 8), financial

book DD&A (line 9), taxes (lines 11-14), Non-cash charges (line 16),

and terminal value (line 20). Although one might quibble with some

details, I find the exhibits properly represent the free cash flows

suitable for use in a discounted cash flow analysis. This is not to say

the numbers are necessarily accurate, only that they are manipulated

properly in the exhibits. Overhead As discussed in the Diamond

Chemical case, overhead does not mean fixed. Variable overhead is

relevant to valuing MW, fixed overhead isnt. Absent information to the

contrary, it seems appropriate to consider these costs variable. This is

a little tricky. The exhibits calculate profit contribution based on

financial book reporting numbers. They subtract financial book DD&A

to calculate net income before taxes, and then they subtract total

income taxes (or more commonly, provision for taxes) to calculate profit

contribution (or more commonly, net income after taxes). Finally, the

exhibits determine cash flow from operations by adding back financial

book accounting and deferred taxes, both of which are non-cash

charges. The resulting cash flow from operations is correct. This is

made more confusing by the fact that, contrary to most investment

opportunities, deferred taxes are negative every year, making current

taxes paid higher than provision for taxes. This also means that the

adding back of deferred taxes actually reduces cash flow from

operations. Note, too, there is a little circularity going on here because

the value of MW and the level of DD&A expenses depend on one

another. The authors of the exhibits have sidestepped this problem by

basing depreciation on a ballpark number for the value of the business.

With more information about the depreciation methods employed, we

could eliminate this circularity. Here, we must accept the (probably

modest) error involved. Taxes As just noted the correct tax figure is

current tax, and the exhibits arrive at this figure by first subtracting total

income taxes, and then adding deferred taxes back. This is part of the

same DD&A taxes story. And in conjunction with the treatment of

these other items, the treatment of Non-cash charges is correct. A

terminal value estimate is clearly necessary. And with a wasting asset,

the approach taken appears appropriate. We might ask if the terminal

value includes estimated values of remaining assets, including land,

when the reserves expire. We might also ask why a 13% discount rate

was applied without explanation or justification. My calculations below

suggest this discount rate might be a bit on the high side, but not far

from the mark.

Financial book DD&A

Non-cash charges

Terminal value

Hence, production and cash flow forecasts for probable reserves often

had to be risk-weighted based on available data and historical

experience in comparable fields, to arrive at an estimate that reflected

their expected value. What do you think it means to risk-weight cash

flows? Heres my interpretation. The correct free cash flow to use in

discounted cash flow valuation is the annual expected free cash flow.

When the annual distribution of free cash flows is symmetric, the

expected free cash flow equals the most likely free cash flow. Absent a

symmetric distribution, this is no longer true and it becomes necessary

to weight the outcomes by their probability of occurrence to calculate

the expected value. The cash flows from the less certain reserves are

likely to be asymmetric because there is a meaningful chance that

future energy prices will make it uneconomic to exploit the reserves.

Heres an example. There are three possible outcomes: $100, $50, and

-$50 with probabilities of 20%, 50%, and 30%, respectively. The most

likely outcome is $50, but the expected outcome is $30 (.2x$100 + .5x

$50 + .3x-$50). The correct number for valuation purposes is $30. 5.

(30 points.) Assuming Apache will borrow up to the 50% ceiling

mentioned on page 7 of the case to finance any acquisition of MW

Petroleum, execute a discounted cash flow valuation of all of the MW

reserves described in Exhibits 3-7. (Please assume the 50% ceiling

applies to proved developed reserves.) The easiest way to value MW

Petroleum is via Adjusted Present Value. As always, a WACC valuation

or an equity valuation are theoretically possible, but quite difficult to

apply. To implement a WACC valuation, we need to estimate Apaches

WACC at its postacquisition capital structure. This is difficult because

we need to know the post-acquisition market value of Apaches equity,

which presumes we know the market value of MW Petroleum the

precise value we seek to estimate in the first place. We can get around

this by solving for the WACC and the market value of MW Petroleum

simultaneously, but this is not easy. A second problem is that because

MW Petroleum consists of wasting assets, the amount of debt it can

support each year in the future will decline, meaning that a different

capital structure and a different WACC exists each year in the future.

Again, we can handle this problem mathematically, but it isnt easy.

Finally, of course, Apaches WACC will not be the appropriate discount

existing assets. An equity valuation faces the same problems on

steroids because the cost of equity capital is much more sensitive to

changes in capital structure than the WACC is. Moreover, because we

ultimately want the enterprise value of MW, not the equity value,

estimating the equity value needlessly complicates the valuation. To

implement an APV valuation, we need to do two things. First, estimate

the all-equity value of MW by discounting the free cash flows in

Exhibit 7 by a suitable all-equity cost of capital. And second, estimate

the present value of the interest tax shields associated with use of debt

to finance the company. Step two involves estimating MWs debt

capacity, deciding how this capacity changes over time, and finding the

present value of the resulting interest tax shields at an appropriate

discount rate. The value of MW is the sum of its all equity value and the

present value of the interest tax shields.

the all-equity cost of capital, ig is a riskfree interest rate, is MWs

asset beta, or its unlevered beta, and Rp is a market risk premium.

Because this is a 15-year asset, I chose to use the 10-year Treasury

rate of 8.03%. The 30year rate of 8.24% is also plausible, as is the 30day rate of 6.52% -- although my strong preference is for one of the

longer-term rates given that we are valuing a long-term asset. Exhibit 2

provides Apaches asset beta and the mean asset beta of six

independent energy companies including Apache. I prefer the mean

asset beta because I want an industry beta, not Apaches, and because

I know for statistical reasons that the average of several observations

should a more accurate estimate of the industry beta than a single

observation. The mean beta is 0.64. (This might appear low but

remember that beta captures systematic risk, and much of the risk in

energy companies is unsystematic.) My preference for Rp is the

historical arithmetic excess return on common stocks relative to

government bonds, or about 7%. An historical geometric excess return

of about 5.5 percent is also defensible. (If you want to follow Brealey

and Myers and use a short-term riskless rate of interest and an

arithmetic excess return on stocks over short-term government bonds,

a risk premium of about 8% is also acceptable.) Combining these

numbers, my estimate of the all-equity cost of capital is 8.03% +

0.64x7% = 12.5%. Using a 5.5% market risk premium, the rate is

8.03% + 0.64x5.5% = 11.6%. The all-equity value of MW Petroleum.

The present value of the free cash flows in Exhibit 7 (lines 19 and 20)

discounted at 12.5% equals $488.5 million. (The corresponding figure

discounted at 11.6% is $512.3 million.) Value of interest tax shields.

Banks will lend up to 50% of the value of proved developed reserves.

The present value of the free cash flows from proved developed

reserves appearing in Exhibit 3, discounted at 12.5% is $392.2. (The

corresponding figure discounted at 11.6% is $408.1 million.) Half this

amount is $196.1 million. Apaches borrowing rate on MW acquisition

debt is uncertain. The company is presently Ba3 rated, which is

equivalent to BB, but it will be pushing the envelope on MW financing,

and the last paragraph of the case mentions B-rated debt. I will

assume a rate equal to the average of BB and B as shown in Exhibit

10 for Feb. 91, or 14.8%. Other rates in this neighborhood are, of

debt. BB is investment grade, while B is junk.) Apaches first year

interest expense will thus be $29 million. What will it be in following

years? When valuing companies with indefinite life expectancies it is

plausible to assume this figure will be constant in perpetuity, or even

grow with the firms cash flows. Such assumptions appear

inappropriate here. Apache is using aggressive financing, so it is

probable that the lenders will push for expeditious reduction in the debt

outstanding. And because MW is a wasting asset, it is impossible to

argue that it will be able to support constant or growing debt levels.

One reasonable approach is to assume that debt outstanding will

continue to equal 50% of the value of proved reserves and will decline

as this value declines. A similar, but simpler approach is to assume

interest expense declines in proportion to cash from operations (line

17) from proved reserves, or 9.8% per year (-9.8% is the IRR from

investing $94.7 million at time 1 and receiving $22.2 million at time 15).

The value of Apaches annual tax shield is the interest rate times the

companys marginal tax rate. Knowledge of the marginal corporate tax

rate in the US in the early 1990s, or comparison of Net income before

taxes (line 10) with Profit contribution (line 15) in Exhibit 3, suggests a

marginal rate of about 35%. A fundamental principle is that the discount

rate employed should reflect the risk of the cash flows discounted.

Here the cash flows are interest payments to creditors, which are quite

predictable. So a plausible discount rate is the borrowing rate on the

debt, or 14.8%. Somewhat higher rates could also be justified. (This

rate is higher than my all-equity cost of capital, but remember that

costs of capital are after-tax numbers while 14.8% is before tax. For an

explanation of why we want a before tax number when discounting tax

shields see the footnote in A Note on Business Valuation on the class

Web site.) Applying the perpetual growth equation with next years

cash flow equal to $10.2 million (.35x$29 million), a discount rate of

14.8% and a growth rate of 9.8%, yields a present value of tax shields

equal to $41.5 million (10.2/[.148 - .098]). This number is likely too high

for at least two reasons. First, it ignores the partial offset of corporate

borrowing at the level of personal taxes, and more importantly, it

ignores all costs of financial distress due to debt financing. I will

consider these factors in my answer to question 7 below. One might

also consider them here as part of a comprehensive discounted cash

flow valuation. Wherever you consider these factors, you should

consider them somewhere. The case (page 5) mentions $25 million in

other opportunities, saying that both parties had apparently agreed to

this figure. My estimated value of MW Petroleum is thus $555.0 million

($488.5+$41.5+25.0). 6. (10 points.) Describe any real options that

might be embedded in the MW Petroleum acquisition. In qualitative

terms, how might these options, if any, affect the value you calculated

in question 5? Important real options are embedded in this investment.

Acquiring MW Petroleum gives Apache the right but not the obligation

to develop three categories of reserves: the proved undeveloped, the

probable, and the possible reserves. For each of these categories, the

case notes (pages 4-5) that significant expenditures are required for

further study, engineering, and development, and that such

opportunity to make them. Because oil and gas prices have been so

volatile, these options are plausible quite a bit more valuable than a

conventional DCF valuation would suggest. The idea is simply that

Apache can choose not to make these expenditures if energy prices

make then uneconomic. 7. (10 points.) Assuming financing is available

and ignoring any embedded options, recommend an opening bid and a

walk-away bid for Apache in its negotiations for MW Petroleum. Any

reasonable answer is satisfactory here. The answer should be related

to the estimated DCF value. And it should reflect any irreducibles that

affect value but are not captured in

the numerical analysis. Candidates include the fact that the case cash

flows appear not to include Apaches superior cost structure as well as

failure to include distress costs and the offset created by personal

taxes in estimating the value of interest tax shields. The answer should

also reflect some kind of negotiating strategy in picking an opening bid.

My bidding strategy would be to work jointly with Amoco to refine the

cash flow projections contained in the case, possibly pushing for more

conservative price projections and reserve estimates if my independent

sources of information could justify them. However, I would accept

Amocos estimates of operating costs, hoping not to reveal

improvements Apache could achieve. My opening bid would be the

resulting DCF estimate of MWs all-equity value. Using my existing

figures, this would be $513.5 million. I would be willing to raise my bid

to include about half of the value of the interest tax shields and half of

the savings I expected to reap from Apaches more efficient operations.

This would probably put my walk-away bid somewhere in the range of

$575 - $600 million.

Mw Petroleum Case

MW Petroleum Corporation

Situation Overview: Amoco Corporation conducted an extensive review

of its cost structure and profitability, leading to major restructurings to

better focus on its core businesses. The result of this was a divestment

of the middle section of its assets along the marginal curve. Thus,

creating MW Petroleum Corporation a new, free-standing exploration

and production oil and gas company. MW was offered to a number of

targeted international petroleum concerns, but the most attractive offer

came from Apache Corporation. In late 1990, the group of Amoco

Corporation and Apache Corporation began talking in regards to the

possible acquisition of MW Petroleum Corporation from Amoco to

Apache. If the acquisition pushes through, it will provide Apache a

great opportunity as well as becoming one of the largest acquisitions

since MWs size is two times larger compared to Apaches current

operation. Nonetheless, Apache must first carefully evaluate MWs

value to come up with a proposal that would be attractive for Amoco

and profitable for Apache as well. The following paragraphs will discuss

the latter.

1. In the lights of low oil and gas price in the market, big companies,

such as Amoco seek to restructure in order to increase profitability.

Amocos plans are to reduce its capital and exploration that are not

generating significant returns or the company not having advantage

with the returns. The intention of the company is to review its assets

with an eye toward selling unprofitable properties or business lines

that do not meet its objectives. Doing so, will allow Amoco to improve

their operating efficiency. Apache Corporations strategy is rationalize

and reconfigure by acquiring inefficient assets and turning them

around via cross cutting. The turnover assets can be retained or sold to

other buyers. With such efforts, Apache is attempting to improve their

oil-gas ratio to hedge against the high volatility of gas prices. Apache

also wants to be more geographically diversified and acquiring new

assets, such as MW, enables the company to do that.

a couple of reasons. One, the high over-head cost under Amoco, the

operation is not as profitable. On the other hand, Apache has a lot of

room to do cost cutting. Two, since Apaches objective is to expand and

rationalize their properties, adhering to their strategy of growth would

require them to develop and acquire oil and gas reserves. Thus, MW

Petroleum would allow for Apache to double their reserves in the

future. This investment can lead Apache to increase their assets and

investors, and overall, the deal is likely to be a win-win situation for

both parties, if they can reach a reasonable price to accept.

Furthermore, between the two companies, the MW Corporation is more

valuable for Apache, because it would bring benefit for them by

expanding their properties and generating income through the

stabilization of a better oil-gas ratio, a diversified geographic location,

and an increase in the number of oil and gas reserves. Yet, if MW

remains with Amoco then it would be part of the least profitable

properties. Apache's main source of value is to expand and diversify

their asset base while the Amoco's main source of value is to limit their

cost, and eliminate the business with a less profitable. In essence,

acquiring MW would be the most beneficial for Apache because not

only will it be good for production, but also with enlarging the ability of

Apache to take on more debt.

2. DCF valuation is a popular method used in valuations of a project or

asset by using time value of money. All estimated cash flow is

discounted to present values using the discount rate which is the cost

of capital incorporated with the risk of the project. The MW Petroleum

Reserve is composed of Proved, Probable and Possible Reserves. The

unlevered beta of equity was calculated using Exhibit 2, 0.82, with a

risk-free rate of 8.24% (the 30 year government bond), and a risk

premium of 5.85%. Therefore, the unlevered cost of equity resulted in

13.037%. To calculate the tax shield, we used

tax rate * income tax provision with a 12% cost of debt. By using the

DCF valuation and Exhibit 7, the NPV is 472.4 and NPVF is 83.28

while the total APV is 555.7 million.

Amoco and Morgan Stanley. It is up to Apaches operation

management to decide if they can actually achieved such operating

cash flow and how efficient they are in terms of executing the cost

cutting efforts. However, at the same time, the DCF method did not

take into the consideration the time we have to exercise the option,

which gives the options more value than exercising right away. The

combination result, in sum, can be ambiguous.

3. MW can be thought of as a combination of assets-in-place and

options. Assets-in-place pertain to properties that already provide cash

flow. In this case, the machineries deployed in the proved developed

reserves as well as all the proved developed reserves would be most

appropriate. The option will be depend on whether or not we are

spending capital expenditure to further exploit the other reserves

(proved undeveloped, probable, and possible reserves) in each case.

Also, the company has the option to spend money to further explore

the area in hopes for more reserves to be discovered and find new

ways to optimize production. This approach could yield a lower value

than APV that was employed above because it takes into account the

time value and the risk of the project.

4. Moving forward, we would use the NPV of proved developed reserve

segment as the estimate of the value of assets-in-place for MW

Petroleum, since the whole segment is largely developed (with

machinery deployed) with minimum CAPX in the future. As a result, we

see the cash flow from this segment as the cash flow generated from

the assets-in-place from MW Petroleum.

Using APV method, we have the total value of proved developed

reserve as:

For the risk of the asset, we would use the revenue of oil and gas as

the weight and their price standard deviation to calculate the weightedaverage standard deviation of the operation for each year of a

particular segment, and average them out in the projected horizon. For

proved underdeveloped, SD is 0.47 with a PV of cash flow of 67.87,

and CAPX is 49.4. We use the 30-year government bond rate, 8.24%,

as the risk-free rate. This results in an option value of 44.44 million.

Using the same method, we can calculate the option for probable

reserves as 42.76 and 30.3. All these numbers plus the assets-in-place

value give the total value of the company, 553.5 million.

Note, that for the option value calculation, we also assumed that the

average lease for the reserve is 6 years (the median value of the 5-7

years range for the company to exercise the rights to exploit).

5. Assuming a sale goes through, Apache should exercise their option

before the expiration of the option. In theory, the option will have the

highest worth at the expiration day. However, in the case of MW

Petroleum, they should exercise the option before it is matured. MW

Petroleum has even a bigger size than Apache. By making the

transaction, Apache will be heavily leveraged to fund the acquisition.

For the company itself, exercising the option can provide additional

revenue stream and eventually more cash flow to cover high interest

payments. To the lending banks, they will lend according to the value of

the proved reserves. This creates some incentives for Apache to take

on the option and discover more proved reserves to have a better

lending environment and liquidity. Furthermore, when the new

operation gets launched and, assuming properly managed by Apache,

the company can have the flexibility to either sell the operation to

another buyer to pay down debt or obtain it for future cash flow.

Mw Petroleum

Company Name: MW Petroleum

Amoco Corporation was the fifth largest oil company in United States

with 28 billion in operating revenues and 1.9 billion in net income. The

low oil prices in the 1980s depressed the profitability of many oil

companies and most of which responded with downsizing and other

cost cutting measures aimed at overhead expenses. Amoco had

already sold more than 750 million worth of small properties, which it

felt could be more economically operated by companies with low

overhead costs. Amoco conducted an extensive study on capital

structure and profitability in 1988 and found that 85% of its margin in

United States was provided by 11% of its producing fields and rest had

disproportionately high overhead costs and repair costs. Based on this

a strategy was formed to divest up to 1.2 billion worth of additional

properties.

As the spinoff could take almost two years it was decided to assemble

the properties in a new free standing E&P company called MW

Petroleum. In the 1990s MW was up for sale and Apache expressed

interest in the deal. Apache, a Denver based operator of smallmedium sized properties was an efficient and cost effective company

and the business strategy was to rationalize and reconfigure. The

strategy involved acquiring and controlling producing properties, and

quickly turn around the efficiency.

Apache was specifically interested in MW as it was a large company

that would more than double Apaches reserves and was comprised of

properties well suited for its operating capabilities. More over adding

MW would reconfigure Apaches Oil-Gas ratio from 20-80 to 40-60,

which was highly desirable for Apache, due to volatile gas prices. Also

MWs properties would further diversify Apaches operation

geographically. Hence MW properties were more valuable to Apache

than Amoco. Apaches expertise in controlling overhead costs could

make the difference.

Discounted Cash Flow Evaluation of MW Reserves & APV

Unlevered (asset) u = 0.82 (From Exhibit 2)

Risk Free Rate= 8.03 % (Exhibit 10, Considering 10 year US Treasury

bond rates)

Market Premium = 5.5 %

Unlevered cost of capital Ru= Rf + u ( Rm- Rf) = 8.03 + 0.82 ( 5.5) =

12.54%

NPV Unlevered =

Assuming that Apache will maintain the capital structure after

acquisition

Weighted Average Cost of Capital WACC=?

Unlevered Cost of Capital Ru= 12.54%

Average D/E ratio = 50.3% ~= 50%

Average Tax Rate= 35.44%

Cost of debt = 12.3% (From Exhibit 10, Moodys Ba3 equivalent to S&P

BB)

WACC = (0.5 x 12.54) + (0.5 x 12.3 x [1-35.44%]) = 10.24

APV= Unlevered NPV+ PV of Tax Shield

APV = 486.8 + 80.88= 567.68 M $

The estimate is most likely biased low as the initial debt value is fairly

low. One reason is due to the assumption that additional assets are

options and cash flow is mostly deriving from further exploration

decisions. Another reason is the method chose to calculate the PV tax

shield. To find the PV tax shield, the projected tax expenses was used,

calculated the tax shield for each year, and discounted the tax shield

with cost of debt. The market premium could be a source of bias as

than projected above

The MW assets can be considered as a portfolio containing assets in

place and real options. The Proved developed Reserves is considered

to be the assets in place. The rest of the reserves like proved

undeveloped reserves (as it needs 35M investment to bring this

reserve in to production and management can always chose to

produce or not to), probable reserves, possible reserves are

considered to be options. There are 25 M worth other opportunities,

and this cash flow is mainly derived from further exploration. Again this

can be considered as an option because if the management doesnt

chose to take this option, the stream of cash flow simply wont exist.

These options are similar to call options and Black & Scholes model

can be used to find out the values of these real options. These real

options estimated are generally more than the APV estimates as it

accounts for the cash flows that can arise from exercising a particular

option. However if we do a sensitivity test, we could see some

instances the real option projections are falling, depending on the

interest rates, volatility etc.

Real options

NPV = NPV Proved Developed Reserve + NPV (Real Options)

NPV Proved Developed Reserve

Proved undeveloped reserve

Incorporating Capex

(13.3)+17.5 = 4.2

Option is valid for 5-7 years. Assuming average option duration of 6

years

Assuming Volatility =0.5 (Page 6 Under Risks price deviations were

nearly 50%)

(d1) = 0.93275, N (d2) = 0.60714

Call value C= S N (d1) X e-rt N (d2) = 83.1 x 0.93275 45.6 x e (0.0803 x 6) x 0.60714 = 60.46

NPV Probable Resrves

S= 74.0, X= 35.7, r = 8.03%, d1 = 1.60119, d2 = 0.376449, N (d1) =

0.945333, N (d2) = 0.646708

Call value C= S N (d1) X e-rt N (d2) = 74 x 0.945333 - 35.7 x e(0.0803 x 6) x 0.646708 = 55.69

NPV Possible Reserves

S= 85.5, X= 90.3, r = 8.03%, d1 = 0.96152, d2 = -0.263221, N(d1) =

0.831855, N(d2) = 0.396190

Call value C= S N(d1) X e-rt N(d2) = 85.5 x 0.831855 90.3 x e(0.0803 x 6) x 0.396190= 49.06

Real Option

The maximum offer price for MW petroleum

585 Millions

The maximum offer price for MW petroleum

585 Millions

All these assets are sensitive to volatility of Oil & Gas Price, Maturity

duration, interest rate of debt etc. Given the political conditions in early

nineties it could be concluded that prices were highly volatile. The

volatility was around 50% at the end of January 1991 whereas early

1990 the volatility was around 30%. The volatility can be estimated

based on the historical data.

A sensitivity analysis on maturity options shows that the offer price

increases with maturity, volatility and interest rate. Apache can differ

the proved undeveloped & probably reserves from 5-7 years. To ensure

below.

Raising enough finance is also a challenge for Apache and differing

option exercise can ensure that sufficient cash flows streams are

established before Apache start exercising options one by one.

Conclusion: This deal will be a good opportunity for Apache to expand

its business and add shareholder value. The only foreseeable hurdle is

Apaches ability to raise the capital. Based on the situation Apache

could loan only 50% of the proved reserves value. In order to raise the

rest of the amount it could work out a deal with Amoco, either to

guarantee Apaches external debt or by striking a production sharing

agreement.

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