Sprigg Lane A Harvard Case Solution & Analysis

SPRIGG LANE DILEMMA

The dilemma for Sprigg Lane is basically to decide that whether to drill or not for the Bailey prospect opportunity. The main issue here or the challenge which the management of the company is facing is that whether or not Sprigg Lane natural resources should be invested in the Bailey Prospect natural gas opportunity.

CASE ANALYSIS

The bailey prospect opportunity is a project to make 10 wells. This project has a 90% chance of being successful. In this case the rate at which gas should flow from the well will not be known until the project has been completed. The gas initially would flow at a rate of 33,000 mcf (thousand cubic feet) per year then decline like in the schedule shown in Exhibit 1.

The net present value calculation for the three scenarios has been performed on this basis:

1) A 12.5% royalty payment to the owner of the mineral rights is deducted from revenue which gives us net revenue.

2) The payment for energy would be approximately $300 per month to operate the well. An additional $3,000 per year for other expenses associated with the lease that might be incurred but cannot be accurately forecasted. Inflation was also incorporated.

3) Local taxes of 4.5% of the gross revenue would be paid.

4) Depreciation expense was equal to the intangible drilling cost, which was 72.5% of the total well cost. The remaining cost was depreciated on a straight line basis.

6) The difference between profit before tax and depletion was deducted as the state income tax.

7) Federal income tax was calculated by multiplying the tax rate times the profit before tax less depletion and state tax paid. Further adjustments were made to it as required by the Section 29 of the tax code.
The net after tax cash flows were calculated by adding back depreciation and depletion to the after-tax profit.
FINAL DESCISION

Based on the calculation of the risks involved in the project and after incorporating all the uncertainties related to the gas production, gas quantity to be produced, total well cost, BTU content, production decline, discount rate and proper inflation value to use, it is recommended to the management of the company to follow the base case information. It should go forward with this lucrative drilling project. The NPV for this case would be $110,263. This would maximize the wealth of the shareholders and the ultimate value of the company......................

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President of natural resources, exploration company must decide whether to invest in new opportunities drilling. He already has a table that projects the most likely scenario for the well and expects to NPV and IRR. However, six of uncertainty discussed the president and other potential investors. He also prepared a table for a couple of lack of scenarios - one where the gas can not be made after the well has been drilled and the second, where the gas is produced and all other sources of uncertainty in the worst 1% of their possible values. Student file list will be available for use with this case. "Hide
by Samuel E injuries, Larry Weatherford Source: Darden School of Business 12 pages. Publication Date: 05 April 1991. Prod. #: UV6136-PDF-ENG

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