Investment Evaluation by Present-Value Profile

There is a trend today for business enterprises to be more thorough in their approach toward making capital expenditure decisions. Correspondingly, there has developed a large volume of literature dealing with problems connected with the analysis of capital expenditure proposals or opportunities. Much of the literature describes methods of preparing economic data for analysis; recently, however, there have been many papers on the subject of measuring the worth of the investment opportunity. This paper deals with both areas. It attempts to describe methods useful to the analyst in presenting economic data to management. It is believed that these methods provide optimum utility for decision making. The paper also describes the limitations of the methods and the ways they might be viewed or interpreted by management in various financial positions. The prosperity of the petroleum industry, perhaps as much or more than any other industry, is dependent on the efficient employment of its capital. This particularly is true in the producing end of the industry because a large part of its assets are continuously being depleted and must be replaced by additional capital expenditures. It has been estimated that capital expenditures for the domestic industry as a whole will exceed $7 billion during 1959, and that drilling and producing investments alone will amount to $4.5 billion. Thus, investments in producing and drilling operations will exceed $12 million daily, on the average. It is readily apparent that management is confronted with a tremendous job in making decisions on a vast number of investment opportunities. Oil industry executives usually rely upon economic analyses prepared by staff groups, particularly geological and engineering staff groups. The economic analysis normally is based on engineering or geological studies of the particular venture, which are usually highly complicated and contain many assumptions. Assumptions are necessary when certain data are unavailable or for the inclusion of future aspects into the analysis, and these assumptions always result in a degree of risk. Management normally attempts to evaluate risk by understanding the mechanics of the technical study; however, the economic analysis, to be complete, should provide for the measurement of the risk factor as well as the profitability.