comments fyi forwarded rakesh bharati na enron 03 27 2001 07 43 pm sheridan titman 03 27 2001 06 46 31 pm rakesh bharati enron com cc subject comments rakesh thanks input quite useful helping clarify thinking following responses comments clarifications ed paragraphs others 1 money set aside avoid negative values clear mean values cash flow pv node anyhow shall setting aside money specific node nodes cross section time risk free asset pays states nature done every time negative realization thus typical project value risk capital may extremely high following tail based norm anymore agree confusing needs refinement concerns discounting negative cash flows discussed first memo clearly provides conservative estimate firm value measure risk capital high perspective evaluating appropriate level risk capital sufficient enough capital employed pv node positive also one might want set level pv positive say 98 nodes 2 memo appears suggest debt capacity contingent values positive issuing risk free debt also project single negative value cross section time positive debt capacity conservative initial estimate model refined probably want define debt capacity project defaults certain percent time 3 seems optimization argument discount rate obtained step comparison investment equating variances clear changing discount rate effect project variance lead global convergence assuming change discount rate major effect volatility fact think process requires one iteration volatility independent discount rate idea calculate volatility project value calculated initial discount rate using calculated volatility stock comparison firm calculate appropriate discount rate volatility project value affected change discount rates done however change discount rates changes volatility may iterate let know makes sense also project finite life market based assets infinite lives light fact define relevant variance spot variance returns comparison investment good point thinking terms average variance may correct actually know approximation need think whether good approximation typically firms tend ignore issues relating duration project cash flows determine discount rate clearly make sense requires additional thought 4 finally criterion subtract average pv investment also risk capital setting risk capital zero model closely resembles intuitive present value criterion endogenously determines discount rate correct goal come something closely related already gives insight define risk capital appropriate discount rate number ways refine improve procedure need first consider whether basic approach makes sense kind projects evaluating gas field case facilitate thinking providing gas field example invest x million dollars buy develop gas field profile expected production variance production per year available engineers beginning production autocorrelated profile shift based actual gas reserves less estimated reserves assume life field 10 years salvage value fixed variable operating costs might useful think applying framework problem problem probably pretty straightforward unlikely cash flows negative gas field producing hence need concerned risk capital x million dollars buy develop property value property assuming equity financing calculate value process developed project compare volatility comparison investment whose value process observable e g traded mlp risk adjusted return comparison investment would used discount cash flows gas field please note procedure requires relatively strong assumptions calculating risk adjusted return comparison investment necessarily straightforward let know would like discuss another topic possible give information one case enron bought sold base load power plant purchaser financed transaction non recourse debt would like following information 1 value power plant purchase price 2 amount debt financing terms debt contract 3 information pricing gas power swaps options year ago gave vince paper develops pricing model project debt think thought could implemented type projects enron finances however coauthors would like try applying model one case study let know want discuss issues thanks sheridan sheridan titman department finance college business administration university texas austin texas 78712 1179 512 232 2787 phone 512 471 5073 fax titman mail utexas edu