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1. Management Sciences 261, Winter 2012
Assignment #1
HAND IN: by 5:30 p.m., Wednesday January 18, in the Management Sciences drop box across from CPH‐2367 (where
CPH meets E2), in the slot for your section, labeled “MSCI 261‐Fuller‐XXXX,” where XXXX is your lecture time, 8:30 or
10:30. Do not put yours into a slot for another Man. Sci. course, or it will get lost!
LATE POLICY: 20% off if one day late; 50% off if 2 days late; 100% off if 3 or more days late.
REMINDER from course outline: You may consult with other students about your written assignments, but the
work that you turn in must be your own. For example, you may discuss with other students how to create a
spreadsheet, in general terms, but you must code the spreadsheet yourself. Do not copy another student’s
spreadsheet file or part of another student’s spreadsheet file. Do not “lend” your spreadsheet file to another
student. Anyone violating these guidelines will be reported to the Associate Dean for Undergraduate Studies;
the typical punishment is 0% on this assignment, and 5% deducted from your course mark.
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Question 1. (A spreadsheet problem) [80 marks]
The ABC Oil Company has found an oil deposit, and now they are trying to decide whether to spend more money
to drill “production” wells, to purchase production equipment, and to operate it for 10 years. For the first 3 years of
production, the natural pressure of the oil in the rocks will drive the oil to the surface, and the rate of production of oil will
be constant from one year to the next. However, after the third year, the natural pressure will decline as more and more
oil is taken out, and the rate of production of oil will decline each year compared to the previous. By the end of year 7,
the rate of production will have declined so much that it will be necessary to buy and install equipment to inject carbon
dioxide (CO2) collected from a nearby coal-fired electric power station; the CO2 injection will maintain the pressure such
that the production rate of oil is constant for years 8 to 10, at the year 7 rate. At the end of the 10th year, the cost of
dismantling the old equipment will approximately equal its scrap value, i.e., the “salvage value” is zero. The oil that is
produced will be sold at the world oil price, but this is the most difficult parameter to predict: it has sometimes been
rising, but it has even sometimes been falling in recent years.
Your task is to prepare a well-documented spreadsheet that calculates the present worth of the proposed
investment in the production well. You will use the spreadsheet for three different assumptions about the world oil price:
slow decline, zero rate of change in price (steady price), and rapid growth in the price, i.e., to calculate three different
present worth values.
Parameter Values
Interest rate that ABC uses for discounting = 12% per year
First cost, now, of production well and equipment = $2,500,000
Cost of CO2 injection equipment at end of year 7 = $1,100,000
Operating cost, during years 1, 2, 3, 4, 5, 6, 7 = $55,000 per year
Oil production amount during years 1, 2, 3 = 9,000 barrels per year
Oil production during years 4, 5, 6, 7 = 10% per year less than previous year
Operating cost, during year 8 = $85,000 per year
Change in annual operating cost, years 9, 10 = 6% more than the previous year
Average price of oil in first year = $80 per barrel
- increasing for the next 9 years at the rate = -2% per year (from previous year) [slow decline]
= 0% per year (from previous year) [steady]
= 3% per year (from previous year) [rapid growth]
Directions to Create the Spreadsheet
 Construct a spreadsheet that will print out on one page (see below for some hints). Your name and UW ID number
should be at the top. It should contain a section near the top of the spreadsheet with cells for each of the parameters
(data), together with labels that identify cell contents, and other labels that give the units of measurement. Have just
one cell for the rate of growth of the oil price; change the value for the three different growth cases. The spreadsheet
should calculate and display several things for each of the 11 years of drilling (year 0) and operation (years 1 to 10);
make the year number increase from left to right and show these things in rows:
o the number of barrels of output each year;
o the price of oil each year;

2. o the sales revenue from oil sales in each year;
o the CO2 injection equipment cost at the end of year 7;
o the total cost each year from years 0 to year 10;
o the net revenue each year (revenue minus costs in that year), before discounting;
o the net revenue in each year, after discounting;
o the overall present worth of the proposed investment.
 Use the end-of year approximation for discounting of cash flows: assume that all bills, e.g. for operating costs, are
paid at the end of the year, and that all revenue is received at the end of the year.
 The spreadsheet formulas should contain references to the cells containing the parameters, so that the spreadsheet can
be used to do the calculations automatically for any values of the data. Your spreadsheet should be documented, i.e.
brief explanations should be inserted about what calculations are being performed. In the business world, you would
show your work to your boss, and he/she must be able to understand it, so clarity will count in the marking. Assume
that your boss knows engineering economics, so you don’t have to explain basic concepts or give standard formulas in
your brief explanations; a few words will do. See the solution of Example 2-14 from class (posted on LEARN), for
an illustration.
 Suggestions to make it fit on one page, and be readable:
o use landscape orientation;
o use font size 10;
o make the left and right margins narrow;
o in the table of revenues and expenses for the 11 years, express all dollar values in thousands of dollars (to
make narrower columns possible);
o use italics, or a different font, for cells containing units or explanations.
What You are to Hand In
 A printout of the one-page spreadsheet, for the case of slow decline in the oil price, with the values of all other data as
given above (under the heading “Parameter Values”), showing values of all calculated cells, as well as all labels for
cells (i.e. what is described under “Directions to Create the Spreadsheet .”
 A table of values of the present worth under the three different oil price scenarios, as calculated by your spreadsheet;
i.e., create and fill in a table like this (this part can be handwritten, if you prefer):
Scenario: Slow Decline Steady Price Rapid Growth
Present Worth:
 For each price scenario, state whether or not the proposed investment is acceptable, under the scenario’s assumption
about the oil price.
What You are to Upload to LEARN
 Upload your MS-Excel spreadsheet file to LEARN, so that the TA can look at your formulas, if necessary.
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Question 2. [20 marks]
Draw a cash flow diagram for the cash flows in Question 1, in the steady price scenario (0%/yr. change).
Please show the individual cash flow elements, not the “summary form,” i.e., do it like Figure 2.6 on page 30 of the text,
not like Figure 2.7. Specifically, show revenue, first cost, annual operating costs, and CO2 injection equipment costs with
separate arrows. Label each arrow and show the dollar value associated with each arrow.