W7.2_ Khalid Almamari_Economic Evaluation of Site Power’s Alternatives


  1. Problem Definition

The SCADA facility is using Diesel generators for power supply during its operation with small requirements in absent of OHL connection. Those generators require a lot of rental cost and maintenance through the whole year. However, the company power is available around the field and can be constructed but with little of capital investment to be connected to the power system. The questions is the selection of better option either to stop using diesel generators and buying power from company itself or maintain the stuff as they are now?

  1. Identify the Feasible Alternatives

The alternatives are:

  1. Do nothing and maintain the stuff as they are now. OR
  2. Stop using diesel generators and extension of new OHL connection.

 

  1. Development of the Outcomes for Alternatives
  • Calculate the annual cost of diesel generators rental and the diesel cost.
  • Calculate the annual cost of connection the power along with additional cost for operation.

 

How to calculate MARR:

In this section, I will go step by step in details as requested to calculate MARR to understand the input and pit of it. In this blog, risk scoring is assumed zero as the risk contribution is relatively low compared to WACC and country risk but while re-writing blog 3 then rsik scoring will be considered and calculated:

 

The MARR can be calculated with the following formula:

MARR = WACC + Risk Scoring + Country Risk

 

Capital Asset Pricing Model (CAPM) is calculated by following formula:

Rs = RF + βs (Rm-Rf)

 

Where:

  • Rs = Stock S rate of return
  • RF = risk-free rate of return
  • βs = contribution of stock S to market risk
  • Rm = market portfolio rate of return
  • (Rm– Rf) = market risk premium

 

Weighted Average Cost of Capital (WACC) equals:

WACC = λ (1 – t) ib + (1 – λ) ea

 

Where:

  • λ = the fraction of the total capital obtained from debt
  • (1 – λ) = the fraction of the total capital obtained from equity
  • t = effective income tax rate as a decimal
  • ib = the cost of debt financing, as measured from appropriate bond rates.
  • ea = the cost of equity financing, as measured from historical performance of the CAPM

 

Due to the fact that risk-free rate does not practically exists, the interest rate of a three-month US treasury bill is assumed as the risk-free rate.

Rf = 0.03%

βs = 1.24

(Rm– Rf) = 6.05%

 

Calculating for Rs;

Rs = 0.03% + 1.24 × 6.06% = 7.5%

 

Since the project is not debt financed, it is 100% equity. Therefore,

WACC = Rs = 7.5%

Country Risk = 1.05%

 

MARR = 8.6%

 

  1. Selection of Criteria

Net Present Value (NPV) is the present value of cash inflows and outflows of a firm. It assists in determining the present value of an investment by deducting the entire cash flows.

The alternative with higher net present value is selected.

 

  1. Analysis and Comparison of the Alternatives.

As collected from the field, the total power required per annum is small for the SCADA project but the power will support ESP once converted from self-flow to artificial pumps in additional that generator can’t handle it.

The two alternatives are compared as in the following table at 8.6 % (4) rate for 5 year. [Negative (-) means cost spent]

Comparison Parameter Diesel Generators Company Power
Annual Operating cost (rent + diesel) -45000$ -1500$
Capital Cost N/A -100000$
Total NPV -176161$ -105951$

 

  1. Selection of the Preferred Alternative.

As using government power has higher NPV which is good investment, therefore, it is selected as the preferred project to be implemented for nearby wells.

 

  1. Performance Monitoring and the Post Evaluation of Result.

Such diesel generators will be either return to Rental Company or transfer them to the new wells which are located in new field where there is no power system at all.

 

References:

  1. com, a. (n.d). Economic Evaluation. Retrieved August 27, 2014, from http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=7&cad=rja&uact=8&ved=0CFkQFjAG&url=http%3A%2F%2Fwww.amazon.com%2FEconomic-Evaluation-Projects-Electricity-Industry%2Fdp%2F0863413048&ei=o90FVMfYENOyuATejIHwDg&usg=AFQjCNFXe3PfliGwmLN8rQDY2XeapAlJsA&bvm=bv.74115972,d.c2E
  2. com, r. (n.d). Economic Evaluation. Retrieved August 27, 2014, from http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CCkQFjAB&url=http%3A%2F%2Fwww.robertson-cgg.com%2Fpreg%2Ftraining%2Feconomic-evaluation-oil-gas-projects&ei=at4FVIJFx724BPvsgZAM&usg=AFQjCNHldMYacXD6fHE7pzUbmmNWtvcRYQ&bvm=bv.74115972,d.c2E
  3. edu, p. (n.d). NPV. Retrieved August 27, 2014, from https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=5&cad=rja&uact=8&ved=0CEUQFjAE&url=https%3A%2F%2Fwww.princeton.edu%2F~achaney%2Ftmve%2Fwiki100k%2Fdocs%2FNet_present_value.html&ei=Cd8FVJniHZPhuQTL-oHgCg&usg=AFQjCNHJ8A8vZiPeyGGa6aatsv9HtHkviA&bvm=bv.74115972,d.c2E

(4)  com, w. (n.d). Economic Evaluation. Retrieved September 3, 2014, from https://pmioman14.wordpress.com/

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One thought on “W7.2_ Khalid Almamari_Economic Evaluation of Site Power’s Alternatives

  1. Nice job, Khalid!!!! Important that you never forget that whenever you use NPV, IRR or any of the other financial analysis tools that you first VERIFY and VALIDATE the MARR, otherwise your entire analysis may end up being fatally flawed…..

    BR,
    Dr. PDG, Jakarta

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