Вы находитесь на странице: 1из 20

In less than five, double-spaced, typewritten pages, plus any exhibits,

please answer the following questions about MW Petroleum Corp. This


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

4. (10 points.) Page 5 of the case contains the following statement,


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

rate if we believe MWs assets are safer or riskier than Apaches


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.

All-equity cost of capital. Using the CAPM, Ke = ig + Rp, where Ke is


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

course, defensible. (Note the large spread between BB and B rated


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

expenditures may be deferred for up to 5-7 years without losing the


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.

Now, it is more reasonable to have Apache operate MW Petroleum for


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.

The estimate is biased high because it is prepared by the seller side


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

In order to calculate PV, we need unlevered cost of capital


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

well. As the market premium increases, APV estimate tend to be lower


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%)

S = 83.1, X = 45.6, Risk free rate 8.03, d1 = 1.4966, d2 = 0.2719, N


(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

sufficient cash flows, it is advisable to defer the options as shown


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.