Payout
From ESER oil and gas
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What is payout?
- Payout is defined as the length of time required for the cumulate net revenues to equal the initial investment.
- In other words, payout is the length of time required to get the invested capital back.
What is the Payout Time Method and how is it used to determine the fair-market-value of a petroleum producing property?
- Using the Payout Time Method, the fair-market-value of the petroleum producing property equals the cumulative undiscounted future net cash flow before tax for the first 2 to 5 years after the property is purchased.
- Rule of thumb for using payout time method in evaluating petroleum producing properties:
- The maximum time length considered when using the payout time method is to use no more than one-third of the remaining life of the property.
What are the disadvantages to using the Payout Time Method?
- There are several disadvantages to using payout as a measure of profitability in the oil and gas industry:
- The primary disadvantage of using payout is that it provides no indication about the timing of returns that occur before or after payout.
- Payout also does not consider the total profitability of the investment.
- Therefore, payout by itself is insufficient to evaluate an investment opportunity. Payout must be used in concert with other measures such as Net-Present-Value, rate of return, and profit to investment ratio in order to evaluate a net cash flow stream properly.
- For most oil and gas projects, an acceptable payout period is in the range of 2 to 5 years.
- In conclusion, the inherent problem with payout is that it does not consider the timing of returns or the total profit from the oil and gas project.
Rule-of-Thumb for applying the payout valuation method
- A rule of thumb for the maximum time length considered with the payout method is no more than one-third of the remaining life of the oil and gas property.