question archive Plato Energy is an oil and gas exploration and development company located in Broome, Western Australia
Subject:FinancePrice: Bought3
Western Australia. The company drills well off-shore in hopes of finding significant oil and gas
deposits. The firm is considering two different drilling opportunities that have very different
production potentials. The first is in the Northwest Shelf region off the coast of Western
Australia and the other is in the Gulf of Carpentaria between the Northern Territory and
Queensland. The Northwest Shelf project requires a much larger initial investment but provides
cash flows (if successful) over a much longer period of time than the Gulf of Carpentaria
opportunity. The longer life of the Northwest Shelf project also results in additional
expenditures in year 3 of the project to enhance production throughout the project's 10-year
expected life. The expected cash flows for the two projects are as follows:
(a) What is the payback period for each of the two projects?
(b) Based on the calculated payback periods, which of the two projects appears to be the best
alternative? What are the limitations of the payback period ranking—that is, what does the
payback period not consider that is important in determining the value-creation potential of
these two projects?
(c) If Plato's management uses a 20% discount rate to evaluate the present values of its energy
investment projects, what is the NPV of the two proposed investments?
(d) What is your estimate of the value that will be created for Plato by the acceptance of each
of these two investments?