Discounted Cash Flow Valuation of Aggregate Reserves Discounted Cash Flow Valuation – Proved Developed Reserves Discounted Cash Flow Valuation – Proved Undeveloped Reserves Discounted Cash Flow Valuation – Probable Reserves Discounted Cash Flow Valuation – Possible Reserves Question 3 To value MW Petroleum we would consider the assets in place and the option bearing assets discretely. The assets in place consist of the proved developed reserves since they are already producing a determinable quantity of oil and natural gas, as well as the non-producing assets as if developed immediately (valued as the NPV of free cash flows). The expenditures associated with the proved developed reserves are also known with some certainty since they consist primarily of maintenance and replacement costs that follow experience based norms. The NPV is subject to commodity price risk due to volatility in oil and gas prices, as well as uncertainty regarding the discount rate. The options consist of the delay in developing proved undeveloped, probable and possible reserves. In the case of these assets, significant development costs must be incurred to monetize the reserves. In the case of the probable and possible reserves, the estimated cash flows are already risk weighted to account for the uncertainty in producible reserves. The options on these reserves are timing options. By incorporating volatility in commodity prices over time, Apache can value the ability to postpone capital expenditures to develop the reserves until volatility in commodity prices returns to historical levels. It is important that Apache have some level of certainty regarding minimum likely commodity prices over time since these are long-lived projects. These options yield a higher value than the DCF valuation (of the aggregate cash flows). Since we are considering these reserves as potential projects in years five through seven, we use the Black-Scholes model to value the options. The
