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Oil Depletion Allowance
Abstract
The Oil Depletion Allowance projects the income for an oil company that made a $10 million investment in land that is estimated to have approximately 625,000 barrels of oil. The drilling will be done over the next 5 years. The model is the oil depletion allowance, which can be deducted from net income for tax purposes. In each year, the depletion allowance is the larger of two quantities: (1) $16 per barrel of oil recovered, where this $16 is calculated as the unit investment cost per barrel ($10 million divided by the estimated 625,000 Barrel reserve), and (2) 22% of gross revenue up to a maximum of 35% of net income. The tornado chart shown on the last sheet indicates that the mean NPV is most sensitive to the number of barrels recovered in year 1, but all the uncertain inputs have a fairly large effect on mean NPV.
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