• Engineering Economics

• Cash Flow and Equivalence

• Depreciation and Comparison of Alternatives
• Risk Assessments / Probabilistic Estimation of
Underground Reserves and Economic
• Ownership and economics
 10000
 Cash Flow Diagram 8000

 Discount Factors: 6000

 Single Compound: Cash 4000

Flow 2000
 . . 0
 Annual Compound / Single Payment Equivalence: -2000

• Equivalent future amount, F(end of compounding -4000

1 2 3 4 5 6 7 8 9 10 11 12
period n) Time (Years)

 1
P: Present amount
• Present worth, P: i : interest rate per period
n: number of compounding
 periods

 Which calculation method provides a better offer ?

  Uniform Series:
• Compound amount:



• Present worth:



 Gradient Series

 ]

 ]

 Note: In the uniform gradient : cash flow starts in year 2

 How about at the cash flow at end of year 1 ?
 Compound interest vs simple interest ?
 Compound interest : both principal and interest earned
r: nominal interest rate
accrue interest (rate per annum) or
discounted rate
 Effective interest , i: m : compounding periods
during the year


 If the interest is compounded yearly, then the interest rate

per period i is equal to the annual effective interest rate ie.
 If the interest is compounded more than one per year, ie
 1 1= (1+ )m − 1
 Example: what is the effective annual interest rate if a bank pays
4.125% interest compounded quarterly.
 Example: A company plans to give each of 50 employees a
holiday bonus. How much is needed to invest monthly for a year
at 12% nominal interest rate, compounded monthly, so that each
employee will revive a $1000 bonus.
  Why do we consider the continuous compoundingP:?Present amount
 Remember the annual compound :
 F = P(1+i)n
 How about monthly compound ?
 F = P( 1 + r/12)12.t
 How about daily compound ?
 F = P(1+ r/365) 365.t
 Hourly compound ?
i : interest rate per period
n: number of compounding
periods
t: number of year
r: nominal interest rate (% per
year), stated by your banks
Today, a person invests $1000, let’s
see how the return with different
compounding methods after 5 years

 F = P(1+ r/8760) 8760.t Annual Percent Return (APR ) vs

General
 Form: nominal rate ?
1
O & G: production and sale
When n -> ∞
continuously happen in the market
. rt
-> continuous compounding
P .
 Net Revenue = Gross Revenue – Costs , costs: drilling costs,
operating costs, royalty, taxes…
 NPV = Gross Present Value – Discounted 10000
Costs
 Gross present value : discounted Gross revenue
8000

6000

 Simple project screening: Cash 4000

Flow
NPV > 0 : make money
2000

0

 NPV < 0 : lose -2000

-4000
 NPV = 0 : break even 1 2 3 4 5 6 7 8 9 10 11 12
Time (Years)
 Example: Calculate the net present value, NPV, of the following
investment, assuming discount rate r=6.5%/year, compound
yearly.
 A well is drilled at time=0 and the cost is 10 MM$. The estimated
income from the well is 2 MM$ per year, paid at the end of each
year for the next 10 years.
 Rate of Return (ROR or IRR) : is interest rate i when NPV = 0
 How to find IRR ?

 Present Value Ratio (PVR) :



 Present Worth Investment (PWI): sum of discounted CAPEX

 Compare two projects with 2 PVR
 PVR1 < PVR2 : the 2nd investment is better
  Straight Line depreciation
 Depreciate = Purchase price – Expected salvage value = C - Sn


 n: years in the depreciation period

 Book Value
 BVj = Initial Cost – Accumulated depreciation
 ∑

Example: A drilling rig cost $20MM, has a 20 year life and $0.3MM salvage value at the end. If the straight line
depreciate if used, what the book value of the drilling rig at the end of 5th year ?
Example: A machine expected income is $3,100 annually for its useful life of 15 years. Expense are estimated to be
$350 annually. If the purchase price is $25,000, what is the prospective rate of return ?
 What the NPV, Reserves, OIIP
if the project probability apprx.
40%, 50%, 60% ?
  Some definitions/terms:
• Net Revenue Interest (NRI) : % profits earned by investors
• Non-operating Interest: investor share , royalty, production, payment, profit,
interest
• Working (operating) Interest (WI)
• Pooled WI: NRI combined
• Production Payment (PPI) pay from WI for a specified time or production
• Overriding Royalty Interest (ORRI): production kept by owner
• Royalty Interest: Ownership of % production

Example: If the first investor buys a lease for 12 % landowner royalty. The engineers working in the field
are paid 8% ORRI. Then the first investor sells the lease to a new investor and keeps 10% ORRI
what the Net revenue interest for the new investor ?