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Homework answers / question archive / A petroleum project involves production of crude oil from a 5,000,000 barrel reserve
A petroleum project involves production of crude oil from a 5,000,000 barrel reserve. Time zero mineral rights acquisition cost (lease bonus) of $2,000,000 is the basis for cost depletion. Intangible drilling expenses of $1,500,000 will be incurred in time zero. Tangible producing equipment costing $3,000,000 at time zero will go into service in year one and be depreciated using double declining balance on the 7-year depreciation basis considering first full year of Use). Production is estimated to be 350,000 barrels per year. Well-head crude oil value before transportation cost is estimated to be $42.00 per barrel in year one, $43.00 per barrel in year two, and $44.00 per barrel in year three. Royalties are 10.0% of revenues (well-head value) each year. Operating costs are expected to be $3,000,000 in year one, $3,300,000 in yeartwo, and $3,600,000 in year three. The allowable percentage depletion is 15.0%. The effective income tax rate is 40.0%. The investor has other taxable income against which to deduct negative taxable income (No Carry forward is allowed). Determine the after-tax cash flows for years 0, 1, 2, and 3. Expense 100% of intangible drilling costs at the end of first year; Use the larger of percentage depletion (subject to limit rules) and cost depletion.
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