Ajax Petroleum

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Market conditions for residual and gasoline

The markets for the prices of gasoline and residual oil could not be any more different from each other. The market prices of gasoline have remained relatively stable at $39/bbl. Residual oil, on the other hand[o], is extremely volatile. Swinging from the highest price of $35/bbl to lows of $18/bbl, the price of residual oil is currently at $25/bbl. The analysis takes into [p]consideration [q]the volatility by taking the average of the highest and lowest price of residual oil for period of year 1-5 at $26.5 and year 6-20 at $21. In order to further [r]demonstrate the profitability of the project, a sensitivity analysis is performed as follow[s]s:

Average residual oil price year 1-5

$ 23.85 (10% less)

$ 26.5

$ 29.15 (10% more)

Average residual oil price year 6-20

$ 19 (10% less)

74%

59%

47%

$ 21

73%

58%

45%

$ 23 (10% more)

72%

56%

43%

The table above shows that with the current assumption and analysis, [t]the project has a 58% rate of return. The analysis is calculated with a 10% fluctuation of the average price for residual oil for the next 20 years. The table clearly shows that even in the worst scenario (prices increase 10% in both periods), [u]the project still shows a 43% rate of return, exceeding the [v]20% required rate of return. With the sensitivity analysis, the investment in the SDU remains highly cost-effective[w]. Moreover, even though residual oil has these market price volatilities, the long run demand for residual oil remains optimistic. This is because Ajax already has residual sales managers in each district, and these sales managers have developed good long-term relationships. However, the long-term outlook for gasoline demand is much less certain than residual oil.[x]

Conclusion

The results of our assumptions and analysis led to a positive net present value (NPV) of $62.5M and an internal rate of return (IRR) of 58%, far exceeding the company’s required rate of return of 20%. A positive NPV means that all of the returns from purchasing the SDU exceeded the costs of the initial investment, operating expenses of the machine by $62.5M. Therefore, purchasing the SDU machine aligns with Ajax Petroleum’s goal of maximizing shareholders’ [y]wealth.