MW Petroleum Writeup FINAL.docx - Case 2 MW Petroleum(A 1...

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Case 2: MW Petroleum (A) 1. There are three categories of “undeveloped” reserves: “Proven undeveloped,” “probable,” and “possible.” For each of these categories, calculate the unlevered values of the cash flows and terminal values projected in Exhibits 4, 5, and 6, using a straightforward DCF approach, not yet incorporating any insights about real options. What discount rate do you use, and how do you calculate it? The calculations for the cash flows are shown on the attached spreadsheet, in Exhibits 4-6. The unlevered cash flows for “Proved Undeveloped”: The unlevered cash flows for “Probable”: The unlevered cash flows for “Possible”: We used the unlevered rate to perform the DCF for all three categories. For “Proved Undeveloped”, we calculated rE by using the CAPM formula. We were given an unlevered asset beta of 0.82 and we used the market premium of 3.89% 1 to calculate rE (10.65%). For rD, we used the BB rating for Apache’s debt, which is 12.30%. In the case, it mentions that “in 1991, the maximum loan-to-value ratio permitted by banks lending against oil and gas assets was typically 50% of the value of proved reserves.” Thus, we used this information to find D/V and E/V values of 33% and 67% respectively. This allowed us to find an rU of 11.20% for “Proved Undeveloped”. For “Probable” and “Possible”, rU is simply equivalent to rE (10.65%) since there is no debt.

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