Assignment 1
Version B
Having been successful in your business career you have decided to become an Oil Tycoon. Your small developing country of Fredonia needs a new oil supplier and with your background in Accounting, Finance and Economics you are the right person for the job. As an Oil Tycoon, your dream is to establish the Standard Oil Company of Fredonia.
Currently the demand for petroleum based products in Fredonia is growing at a relatively modest rate for a small developing nation. In order to fulfil the demand for oil a refinery needs to be built. So you will have to firstly, find the total cost of supplying oil to Fredonia, then establish the relative merits of building a refinery and finally establish how your profits will be effected by changes in your supply.
QUESTION 1: (10 Marks)
So your company needs to acquire an optimal mix of oil crude types from a group of supplying nations. We assume that the demand (in Millions of Barrels per year) for oil crude types will be 4 Light Crude; 2 Intermediate Crude; 0.5 Heavy Crude in the first year. Furthermore, as your country is growing rapidly you assume that the demand for all petroleum types will grow at a rate of 1.3%/year. The four countries that can supply your oil demand have the following assumed prices and available supply:
Country Ships/year Shipping Cost
Max Min $/Barrel
Saudi Arabia 20 2 5.63
Dubai 20 2 3.35
USA 10 1 4.25
Australia 16 1 2.85

Each Ship is composed of the following oil types
Country Light Crude Intermediate Crude Heavy Crude
Saudi Arabia 60% 20% 20%
Dubai 15% 35% 50%
USA 5% 75% 20%
Australia 30% 20% 50%

Each ship can carry 1 million barrels of oil. Assume the price for:
Light Crude is $65/barrel in year 1 and increases at a rate of 2.3% per year for 20 years.
Intermediate Crude is $51/Barrel in year 1 increases at a rate of 2.1% per year for 20 years.
Heavy Crude is $36/Barrel in year 1 increases at a rate of 2.1% per year for 20 years.
Your linear programme should decide how many ships you should purchase full of oil from each country in order to minimize your total cost of supply for each year for the 20 year forecast.
Assume no oil storage is possible and that excess oil is sold for 50% of the purchase price to other countries in the region.
QUESTION 2: (10 Marks)
After assuming the least cost mix of supplies has now been decided upon from question 1, you must now build you Oil Empire by obtaining a refinery. Using your superior knowledge of Net Present Value and Internal Rates of Return, you must now devise a plan to purchase a $1.45 Billion refinery. Assuming that your refinery can take the above oil supply (Light, Intermediate and Heavy Crudes), you now need to make some Diesel and Gasoline. The refinery uses 3/4 of the oil purchased to make Gasoline and the remaining 1/4 to make Diesel.
To find the potential Total Revenue for each year over the 20 years forecasted demand state the output from your refinery and total revenue
• Using a Base price of $1.3/L for Gasoline and $2/L Diesel
• Assuming the price of both fuels increase at a rate of 2.3%/year
• Assume there are 157L of oil per barrel
• Assume a 62 cents/Litre Fuel Excise Tax which increases at 1 cent per year
Using the Total Revenue from Gasoline and Diesel Sales, your costs of obtaining the oil and a $0.1/L refinery cost, establish the NPV of the project assuming a discount rate of 10%. Then calculate the IRR of the project.
(Hint: when calculating the NPV and IRR use millions of dollars for Total Revenue, Total costs and Profit)
QUESTION 3: (10 Marks)
For the following sub-scenarios write a short analysis on: (2 Marks Each)
• Discuss how/if this project would be profitable at a range of NPV values 8% to 15%
• Discuss how the Capital Cost effects the profitability of the project
• Discuss how if the price of Gasoline only increased at a rate of 1.5% how profitability would change.
• Discuss how if the maximum supply from Saudi Arabia dropped by 30% would affect profitability.
• Discuss if the number of ships from Australia could be increased at a shipping cost of $3.2 would affect your profitability.

Sample Solution