| (A) Once capital structure, debt, and equity costs are determined, the final step in deriving the WACC is to weight the cost of debt and equity by the proportional share each has in the overall capital structure. This is represented by the following equations. Attached Graphic (B) The WACC estimating technique is illustrated in subsection (m) of this section (Appendix 2). (7) Final discount rate selection. (A) As discussed earlier, the typical WACC of potential purchasers sets the lower end of the discount rate range. To help establish the upper end of the discount rate range, the appraiser can calculate a standard deviation of all the discount rates indicated by the sales in the sales sample and the survey. One standard deviation above and below the mean contains 68% of all the observations in a normally distributed set of data. Two standard deviations above and below the mean contains over 99% of all the observations in a normally distributed set of data. The data may not be normally distributed. Even so, this kind of analysis may help the appraiser to establish the upper end of the discount rate range. (B) Very high-risk properties (for example, a one-well lease with high water production near the end of its economic life) may be discounted by the market at two standard deviations above the mean. Properties with lesser risk will have correspondingly lower discount rates. One standard deviation above the mean may establish an upper limit for properties in a typical risk-range. The mean or median of the discount rates from the sales analysis and the survey indicates the mid-range discount rate. (C) For a standard deviation analysis to have meaning in selecting an upper limit to the discount rate range, the survey or sales data set must contain properties with broadly varying risk. A high-end discount rate selected by this method will not apply to very risky properties (it will be too low) unless these risky properties are represented in the sales data set used in the analysis. (D) To select a discount rate for an individual property, the appraiser must assess the property-specific risk inherent in the property. Subsection (o) of this section (Appendix 4) lists risk factors that should be taken into account. (k) Summary. (1) This manual describes methods and procedures used to calculate the present value of oil and gas properties using discounted future income. The discounted cash flow method, DCF, is the most widely used method to appraise mineral properties. (2) Within the DCF equation, there are three generally accepted techniques for estimating a discount rate: market surveys, oil and gas sales analysis and the weighted average cost of capital. Ideally, the appraiser should use these three techniques simultaneously to develop a range of discount rates. (3) The evaluation of oil and gas properties demonstrates the importance of viewing a discount rate in the context of the entire appraisal, including the production decline rate, price, and cost parameters. The discount rate should not be considered an isolated variable, for it is only one component of a complex interaction of variables that collectively determine an estimate of value. (l) Appendix 1. Attached Graphic (m) Appendix 2. Attached Graphic (n) Appendix 3. Attached Graphic (o) Appendix 4. Attached Graphic (p) Appendix 5. Attached Graphic |
