PKO Resources, Inc.

Abstract

Pete Carvey, CFO for the PKO Resources of McKinney, TX sat at his desk puzzling over the analysis just presented to him regarding an acquisition his firm was considering. Although this project seemed like hundreds of others that he had analyzed, Pete was bothered by three things: First, the purchase price that had been quoted to PKO seemed very high in light of prices that PKO had observed in recent months. Second, the typical reserve mix for properties that PKO considered was weighted very heavily on proven reserve categories (i.e., proved developed producing, proved developed non-producing, and proved undeveloped). The engineers had told Pete that the Salinas field had substantial prospects for unproved reserves (i.e., typically referred to as probable reserves). In the past PKO had simply ignored the unproved category when evaluating an acquisition but in this instance it appeared the firm would have to place some value on the unproved reserves if it was to have any chance of winning the bid. Finally, Pete worried that his approach to bidding was no longer appropriate as the firm had lost out in all its recent competitive bidding situations. This caused Pete to question the firm's standard approach to arriving at its bid prices. PKO's standard approach to evaluating acquisitions of oil and gas properties is largely static but the firm engages in a number of what if or scenario analyses before arriving at a final number.

Keywords: valuation, capital budgeting, real options, oil and gas

JEL Classification: G31