Discounted Cash Flow as a Measure of Market Value
- Fred S. Reynolds (Ralph H. Cummins Co.)
- Document ID
- Society of Petroleum Engineers
- Journal of Petroleum Technology
- Publication Date
- November 1959
- Document Type
- Journal Paper
- 15 - 19
- 1959. Original copyright American Institute of Mining, Metallurgical, and Petroleum Engineers, Inc. Copyright has expired.
- 6.1.5 Human Resources, Competence and Training
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The discounted-cash-flow method has been used for years in the field of finance and banking. It has been gaining stature for several years in the money management for certain industries, and the oil and gas industry is rapidly recognizing its merit for choosing investment alternatives.
The method is suggested as a measure of market value because it is conceptually realistic and suffers from none of the limitations that the other yardsticks do.
Data are presented that are indicative of profitable levels of return. Comparisons of various measures of value for five actual sales or valuations are given, and the effects of using any one of the parameters of value have been calculated to show the superiority of the discounted-cash-flow method.
An oil and gas investor must place a time value on his money; hence, the discounted-cash-flow method is gaining its acceptance in directing management toward new capital expenditures. It is hoped the method will be utilized and accepted for determining fair market values.
Most engineers whose profession involves evaluating oil, gas, or other mineral interests must sooner or later create hypothetical sales to ascertain the fair market values of mineral reserves. The principal causes for these perplexing situations are the necessities of providing bases for settling estate, gift and ad valorem taxes.
If an engineer were pursuing a valuation so that he could advise management or a client concerning the worth of an investment, his requirement would be extremely similar and should be treated no differently. Any profit-conscious investor must either determine if a desirable level of return is realized for a quoted price or the maximum price that can be paid to yield a desirable level of return. In essence then, this problem leans heavily on the basic requirements of engineering valuations; however, the engineer is often faced with defending his basis for determining worth in the ground in addition to the calculated reserves for the interest. The experienced engineer or investor can often determine the approximate value of an oil and gas interest by prudent examination of the engineering computations; however, many officials are reluctant to ascribe to the experience and prestige the valuator has attained in his profession. It then behooves appraisers to utilize a definitive concept for determining fair market values. There have been many concepts formulated and utilized, and each is characterized by varying intrinsic weaknesses. it is the purpose of this paper to propose a method that eliminates most of the conjectural features.
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