Page 365 - Hydrocarbon Exploration and Production Second Edition

352 Calculating a Discounted Cashflow

100
Cumulative Net Cashflow
80
Cumulative Net Cashflow ($m) 40 1 2 3 4 5 Payback 8 9 10 11 12 13 14 15
60
Time

20

0
6
7
-20

-40
-60
Maximum Time (years)
Exposure
Figure 14.10 Indicators from the cumulative net cash£ow.

14.3.1. Discounting: the concept

Suppose you have to meet an obligation to pay a bill of d10,000 in 5 years time. If
you could be guaranteed a compound interest rate in your bank of 7% per annum
(after tax) over each of the next 5 years, then the sum which you would have to
invest today to be able to meet the obligation in 5 years time would be

5
Investment today ð1:07Þ ¼ d10; 000
d10; 000
i:e: Investment today ¼ 5 ¼ d7130
ð1:07Þ

The PV today of the sum of d10,000 in 5 years time is d7130, assuming a
discount rate of 7% per annum.
What we have calculated is the PV, at a particular reference date, of a future sum
of money, using a specified discount rate. In any discounting calculation, it is
important to quote the reference date and the discount rate.
If you were offered d7130 today, or d10,000 in exactly 5 years time, you should
be indifferent to the options, unless you could find an alternative investment
opportunity which yielded a guaranteed interest rate better than the bank, in which
case you should accept the money today and take the alternative investment
opportunity.
In other words, given the constraints on investment opportunities, the d7130
today and the d10,000 in 5 years time are equivalent. The only difference between
them is the timing and the opportunity to invest at 7% interest rate.