Title: Separate cash flow valuation – applications to investment decisions and tax design

Authors: Magne Emhjellen, Petter Osmundsen

Addresses: Petoro Petoro AS, Postboks 300 Sentrum, 4002 Stavanger, Norway. ' Department for Industrial Economics and Risk Management, University of Stavanger, 4036 Stavanger, Norway

Abstract: Oil project assessment using separate cash flow valuation (Jacoby and Laughton, 1992; Laughton and Jacoby, 1993; Emhjellen and Alaouze, 2002), presumes that the present value of the cost cash flow of oil projects can be calculated using a risk free rate. This paper examines whether this practise, at least to a first approximation, is reasonable. More specifically, the paper examines whether labour wage hours costs and steel prices – as cost factors in the investment cost stream – are systematic risk factors (i.e., have a beta different from zero). The paper also investigates whether oil price as a factor in the revenue stream is a systematic revenue factor. Separate cash flow evaluation has been discussed in relation to petroleum taxation. A petroleum tax commission in Norway stated that tax reductions due to depreciation should separately be discounted by a risk free rate. We discuss the role of partial cash flow discounting in tax design.

Keywords: separate cash flows; corporate finance; project valuation; tax design; tax structure; investments; investment decisions; cash flow valuation; oil project assessment; labour wages; labour costs; steel prices; risk factors; oil prices; petroleum taxation; Norway; tax reductions; depreciation; risk free rate; partial cash flow discounting.

DOI: 10.1504/IJGEI.2011.039984

International Journal of Global Energy Issues, 2011 Vol.35 No.1, pp.43 - 63

Published online: 26 Mar 2015 *

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