Consolidated Natural Gas Company (CNG), with corporate headquarters in Pittsburgh, Pennsylvania, is one of the largest producers, transporters, distributors, and marketers of natural gas in North America.

Periodically, the company experiences a decrease in the value of its gas- and oil-producing properties, and a special charge to income was recorded in order to reduce the carrying value of those assets.

Assume the following information. In 2016, CNG estimated the cash inflows from its oil- and gas-producing properties to be \(375,000 per year. During 2017, the write-downs described above caused the estimate to be decreased to \)275,000 per year. Production costs (cash outflows) associated with all these properties were estimated to be \(125,000 per year in 2016, but this amount was revised to \)155,000 per year in 2017.

Instructions (Assume that all cash flows occur at the end of the year.)

(a) Calculate the present value of net cash flows for 2016–2018 (three years), using the 2016 estimates and a 10% discount factor.

(b) Calculate the present value of net cash flows for 2017–2019 (three years), using the 2017 estimates and a 10% discount factor.

(c) Compare the results using the two estimates. Is information on future cash flows from oil- and gas-producing properties useful, considering that the estimates must be revised each year? Explain.

Step by step solution

01

Calculation for part A

Year	2016-2018
Cash Inflows	375,000
Production cost	-125,000
Profit (cash flow)	250,000
Present Value of annuity factor (10% 3 years)	2.486851991
NPV	621712.9977

02

Calculation for part B

Year	2017-2019
Cash Inflows	275,000
Production cost	-155,000
Profit (cash flow)	120,000
Present Value of annuity factor (10% 3 years)	2.260774537
NPV	271292.9445

03

Calculation for Part C

The estimate of future cash flow is very useful as it provides the information and understanding of whether the value of gas and oil properties is increasing or decreasing from year to year. It also provides useful information for writing down the asset.

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