It is used because the managing director likes it ror

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Unformatted text preview: onehill and Nathanson, 1968), companies report that for significant decisions, a range of decision-making criteria is generated and presented to the board. Organisations weight these measures according to environmental conditions and the particular decision under analysis. As several of the respondents explain, an EMV only tends to be generated by organisations when they are trying to decide whether or not to drill an exploration prospect: “They are used for different things. NPV is very important. EMV is used on a drill or don’t drill decision. … It is used because the managing director likes it. ROR [Rate of Return] is used as well. We always quote NPV and ROR in any conversation. But the others are used.” (J) and, “Drill or not drill is EMV. ROR is important we have a threshold – if an E&P [Exploration and Production] project doesn’t have a ROR greater than a particular threshold … and we use NPV to give us an idea of the size of the project value.” (F) One of the representatives from company R explains why an EMV is only calculated for drilling decisions: “…really because once you’ve made the decision to spend the money then basically EMV becomes a slightly meaningless term because … EMV tends to be used more when you are risking an exploration prospect but once you’ve found something and you feel as though there is a good chance that you are going to make money out of it, then really how do you manage that risk? So it’s the sensitivity around the core, the base value. I would say EMV would tend to be used where you’ve got significant levels of risk of failure, where you are probably more likely to fail than to succeed and that would typically be in an exploration venture. NPV would definitely be used when you’ve found something and you are going ahead.” (R1) Recall from Section 5.2 of Chapter 5, the EMV of an outcome is defined by Newendorp (1996) to be the product that is obtained by multiplying the chance (or probability) that the outcome will occur and the conditional value (or worth) that is received if the outcome occurs. The EMV of a decision alternative is then the algebraic sum of the expected values of each possible outcome that could occur if the decision alternative is accepted. After the decision has been made to drill an 130 exploration well in a field and the presence of hydrocarbons has been confirmed, the chance (or “geological risk” – for a full discussion see Section 5.7 of Chapter 5) of there being a dry hole is zero and, consequently, the EMV of the outcome “dry hole” is zero. However, the dry hole is only one of the outcomes on the decision tree. There are still many outcomes that could occur. For example, the field could contain fifty million barrels or it might only contain ten million barrels. Each outcome has a chance of occurrence and a conditional value that would be received if the outcome occurred. Hence, theoretically, at least, the EMV could be used for all the decisions in the life of an asset. As indicated in Section 5.7 of Chapter 5, this observation has led some companies to differen...
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This document was uploaded on 03/30/2014.

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