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(a) Complete Table 2.6 and show that the total depletion allowance exceeds the original investment. (b) Calculate the PV and the IRR for this investment. Assume an interest rate of 20%.

(a) Complete Table 2.6 and show that the total depletion allowance exceeds the original investment. (b) Calculate the PV and the IRR for this investment. Assume an interest rate of 20%.

Corporate Fin Focused Approach
Corporate Fin Focused Approach
5th Edition
ISBN:9781285660516
Author:EHRHARDT
Publisher:EHRHARDT
Chapter10: The Basics Of Capital Budgeting: Evaluating Cash Flows
Section: Chapter Questions
Problem 14P
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TABLE 2.6 OIL INVESTMENT DETAILS Year 12345 12. (Oil depletion allowance ) A wealthy investor spends $1 million to drill and develop an oil well that has estimated reserves of 200,000 barrels. The well is to be operated over 5 years, producing the estimated quantities shown in the second column of Table 2.6. It is estimated that the oil will be sold for $20 per barrel. The net income is also shown. Barrels Gross produced revenue 30,000 10,000 80,000 70,000 50,000 1,000,000 500,000 200,000 50,000 1,600,000 400,000 1,000,000 Net Depletion Taxable income Option 1 Option 2 allowance income 400,000 400,000 1,200,000 352,000 600,000 200,000 After-tax Tax income 800,000 360,000 840,000 A depletion allowance, for tax purposes, can be computed in either of two ways each year: 22% of gross revenue up to 50% of net income before such deduction (option 1), or the investment cost of the product, equal in this case to the unit cost of the reserves, $5 per barrel (option 2). The allowance is deducted from the net income to determine the taxable income. The investor is in the 45% tax bracket. (a) Complete Table 2.6 and show that the total depletion allowance exceeds the original investment. (b) Calculate the PV and the IRR for this investment. Assume an interest rate of 20%.
Transcribed Image Text:TABLE 2.6 OIL INVESTMENT DETAILS Year 12345 12. (Oil depletion allowance ) A wealthy investor spends $1 million to drill and develop an oil well that has estimated reserves of 200,000 barrels. The well is to be operated over 5 years, producing the estimated quantities shown in the second column of Table 2.6. It is estimated that the oil will be sold for $20 per barrel. The net income is also shown. Barrels Gross produced revenue 30,000 10,000 80,000 70,000 50,000 1,000,000 500,000 200,000 50,000 1,600,000 400,000 1,000,000 Net Depletion Taxable income Option 1 Option 2 allowance income 400,000 400,000 1,200,000 352,000 600,000 200,000 After-tax Tax income 800,000 360,000 840,000 A depletion allowance, for tax purposes, can be computed in either of two ways each year: 22% of gross revenue up to 50% of net income before such deduction (option 1), or the investment cost of the product, equal in this case to the unit cost of the reserves, $5 per barrel (option 2). The allowance is deducted from the net income to determine the taxable income. The investor is in the 45% tax bracket. (a) Complete Table 2.6 and show that the total depletion allowance exceeds the original investment. (b) Calculate the PV and the IRR for this investment. Assume an interest rate of 20%.
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