FINANCE FOR MANAGERS

Finance for Managers

[Name of Authors]

Finance for Managers

Introduction

This report has been prepared to evaluate the investment decision of Phoenix Oil PLC with respect to the project “Falkland Alpha Reserve”. Falkland alpha project is an exploration and commercial drilling project for prospective offshore oil reserves in South Atlantic. Following assumptions have been made in order to evaluate the investment decision in Falkland alpha project by Phoenix Oil.

Assumptions

Phoenix Oil PLC has conducted a geological survey of the prospective offshore oil reserve in South Atlantic. The total cost incurred for conducting the survey is £1 million.

Following three potential oil reserve probabilities have been identified:

Size of Reserve

Probabilities

Dry (None)

30%

Extensive

20%

Limited

50%

If phoenix decides to develop the reserve then two initial investments will be required:

Exploratory Drill: An initial investment of 3 million will be made to drill an exploratory well to see if oil is present in the reserve or not.

Commercial Drilling: If oil is discovered the company will advance with commercial drilling, which will help in determining the actual size (“extensive or limited”) of the oil reserve. Commercial drilling may require a purchase of new equipment at a cost of 20 Million.

According to our estimation, extensive reserve will generate 9 million net additional cash inflows annually and limited reserve will generate 4 million net additional cash inflows annually.

Oil price will remain above $100 ($/Barrel) throughout the production phase.

The reserve is likely to have an economic production life of 10 years.

Phoenix generally uses 10% discounting factor for appraising such projects.

Straight-line depreciation method is used as per company policy.

Making an accurate investment decision is very important because funds are scarce and they should be used with extra care (Anderson, 2005). Hence finance managers should be able to decide whether the investment decision is worth undertaking or not. Capital budgeting provides comprehensive and useful information for management and investment decision. Capital budgeting is a very critical process (Anderson, 2009).

Discussion

In order to analyze and evaluate the investment decision of the project “Falkland Alpha Reserve” by Phoenix Oil PLC, several capital budgeting techniques have been used and discussed in this report. Capital Budgeting is the process which is used to assess the viability and the feasibility of projects and investments. It helps in making investment decision of long term projects by analyzing the future cash flows of the project and its initial investment cost (Ansari, 2000). In order to perform the capital budgeting of a project or investment following variables must be known.

The cost of that specific project.

Expected Cash out flows.

Cost of capital can be calculated, which the management can use to discount the estimated future cash flows.

PV of the future cash flows can be calculated.

Next, PV of the expected cash flow can be comparable to the initial investment outlay. The different capital budgeting techniques used in this report to evaluate the investment decision are:

Net Present Value

Pay Back Period

Accounting Rate of Return (ARR)

Profitability Index

Based on above techniques we will recommend the final investment decision of “Falkland Alpha Reserve” project ...