An oil and gas producing company owns 46,000 acres of land in a southeastern sta

Question

An oil and gas producing company owns 46,000 acres of land in a southeastern state. It operates 600 wells which produce 25,000 barrels of oil per year and 1.3 million cubic feet of natural gas per year. The revenue from the oil is $2,500,000 per year and for natural gas the annual revenue is $567,000 per year. What bid should be made to purchase this property if the potential buyer is hoping to make 12% per year on his investment over a period of 12 years. Click the icon to view the interest and annuity table for discrete compounding when ,-12% per year J million or less should be offered for the property. (Round to two decimal places.)

Explanation / Answer

So we have the total revenue from the land at $3,067,000 (i.e. $2,500,000 + $567,000). Now the buyer would need a 12% return over a period of 12 years. So what we should do is, consider the revenue as an annuity, and then compute its present value at 12%. That would give us the maximum bid amount for the land.

Now the PV discounting table for 12 periods, give us a discounting factor of 6.1944 at 12% per anum.

So what we need to do is, multiply this discounting factor by the revenue from the land and that will give us what we need. Then, $3,067,000*6.1944 = $18,998,224.80

Hope that helps! :)

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