Page 96 - Principles of Applied Reservoir Simulation 2E

Part I: Reservoir Engineering Primer 81

9.3 Investment Decision Analysis

Economic analyses are performed to provide information about the
economic performance that can be expected from a project relative to alternative
investment options. The decision to invest in a project depends on many factors.
Thompson and Wright [1985, pg. 3-2] list the following set of characteristics
for measures of investment worth that can be used to compare and rank
competing projects:
* Consistent with corporate goals.
* Easy to understand and apply.
«Permits cost-effective decision making.
«Provides a quantitative measure for acceptance or rejection,
* Permits alternatives to be compared and ranked.
* Incorporates the time value of money.
The economic measures that are used in investment decision analysis
depend on the experience of the decision makers who will use the economic
measures. Some of the most commonly used economic measures are payout,
present worth, net present value, discount rate, profit-to-investment ratio, and
internal rate of return. The relative importance of each economic measure is
determined by the decision makers. For example, a proposed project with an
early payout but relatively low discount rate may be more attractive to a
company that needs to maintain a positive cash flow than another project with
a higher discount rate but which does not payout as soon. The criteria for
acceptance or rejection of a project may change, even within a company, as the
economic environment changes.
Combinations of economic measures are often used as economic criteria
for making decisions about projects. For example, a project may be considered
economically viable if the internal rate of return (IRR) is greater than 30% and
the profit-to-investment ratio (PI) is greater than 0.5. Economic viability is
influenced by both tangible and intangible factors. Intangible factors such as
environmental and socio-political concerns are relatively difficult to quantify,
yet may have a greater influence on the final decision than tangible factors.
Tangible factors, such as well costs and reserves, are relatively easy to quantify.