Undertaking economic evaluations of projects and business costs is a crucial function performed by companies on behalf of their shareholders to ensure that capital is invested prudently. This guide describes the underlying concepts, measurements and methodologies used by businesses for: evaluating the economics of investing capital in a project; deciding whether to purchase or lease; deriving a cost-of-service (tariff) fee; determining a bid price for an asset or entire company; removing embedded financing costs from project cash flows; deciding whether to keep or sell project component inventory for a deferred project; and, applying special purpose valuation formulas.
This guide is written for project economists, corporate managers, business students, contract lawyers and anyone interested in learning about economic evaluations. No prior knowledge of this subject matter is required.
Approximately 50% of this guide is devoted to the first topic which examines the economic feasibility of investing capital in a project. Project cash flows are defined, certain forms of project costs are restructured, and a typical project investment cash flow profile is examined. The meaning of capital, supply and flow of capital, and cost of capital are described. Economic profitability is measured using the net present value, payout, internal rate of return, and capital efficiency index measures. In-depth descriptions of these four measures are provided and their applications illustrated through simplified numeric examples. A de-financing procedure is applied to remove embedded financing costs from lease and cost-of-service fees to avoid distorting the economic measures.
The remaining topics are described from first principles and are illustrated using simplified numeric examples. The three topics describing the derivation of cost-of-service (tariff) fees, the de-financing of project cash flows, and the determination of bid purchase prices for assets and entire companies are specialized topics not easily located in current financial literature.
This guide is divided into two parts. Part A provides overview explanations of concepts, measurements, and methodologies for all topics and utilizes numeric illustrations at summary levels. Part B describes in more detail the calculations, concepts, methodologies and algebra used to derive the results presented in Part A. With this construct, readers can choose to limit their reading to Part A to obtain a high-level understanding of key concepts and methodologies or readers can choose to dig into the numeric details and explanations by reading Part B as well to develop a more comprehensive understanding.
All calculations are displayed and carefully described but calculations do not explain meanings. To explain meanings, creative illustrations and analogies are utilized extensively throughout this guide. For example, the concept of economic profit is carefully developed and utilized to explain the concept of net present value in a manner not found in other financial books. Analogies are drawn to the common bank savings account to illustrate the meaning of certain economic measures. The difficult concept of cost of capital is explained by treating cost of capital as a cash fee paid by a project to its parent company. This cash fee is divided into three cash components: debt interest payments, stock dividend payments, and a share-value-increase amount determined by financial theory.
Explanations are supported by diagrams, point form summaries, simplified numeric examples and bar charts in 278 figures spread over 300 pages.
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About the Author
Ted Lawrence worked in the Canadian oil and gas industry for 40 years and served as a petroleum economist for most of that time until retiring. Ted performed and supervised a multitude of project economic evaluations for eastern Canada offshore oil development, central Canada petroleum refining and marketing, western Canada oil and gas, Alberta oil sands, the Canadian arctic, mid-western USA, the North Sea, North Africa and the Middle East. These economic evaluations included the appraisals of deep water oil and gas exploration prospects, the development of billion dollar offshore oil-platform projects, the determination of purchase prices for major assets and energy companies, the determination of pipeline tolls, the evaluation of time charter arrangements for marine oil tankers, the leasing of equipment, vehicles, commercial property and aircraft, the evaluation of liquefied natural gas (LNG) projects, optimization of refinery production costs and countless other applications.
Ted instructed numerous in-house economic evaluation workshops in Canada as well as several internationally and authored economic evaluation guidelines and policies for internal corporate use. He was repeatedly asked to recommend a good economic evaluations book. Having not come across such a book, writing this book became his retirement project. Ted participated in many negotiating and lobbying sessions with energy companies, governments and business associations on behalf of his employer.
Ted began his oil and gas career as a university student in the co-op program at the University of Waterloo. He obtained his Bachelor of Mathematics degree from the University of Waterloo in 1975 and earned his Master's in Business Administration degree in finance from the University of Calgary in 1981. Ted worked for three major integrated oil and gas companies during his career.