What ethics lie Beyond Oil?

J. of Acc. Ed. 30 (2012) 307–324

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Educational Case

What ethics lie Beyond Oil? Gia Chevis 1, Marty Stuebs ⇑ Department of Accounting and Business Law, Hankamer School of Business, Baylor University, Waco, TX 76798, United States

a r t i c l e

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Article history: Available online 28 September 2012 Keywords: Capital budgeting Capital investments Safety investments Ethics Responsibility Managerial and cost accounting analyses Decision making

a b s t r a c t Companies’ responsibilities for safety are important social and environmental welfare concerns. This fictional case—inspired by actual events—presents a capital investment decision intended to improve oil refinery safety. Beyond Oil (BO), Inc. has a recently-acquired refinery that is in need of extensive modernization and repair. The case analysis requires you to integrate capital investment analysis methods with consideration of ethical responsibilities. You have the opportunity to consider how to incorporate both uncertainty and qualitative/strategic information into a conventional discounted cash flow (DCF) analysis and to weigh competing claims and conflicting incentives in order to make a recommendation. Ó 2012 Elsevier Ltd. All rights reserved.

1. An uncertain course Still not seeing a clear path to a solution, Julie Wilson, a senior plant accountant at Beyond Oil, Inc.’s (BO’s) Port Arthur, Texas refinery, took a deep breath and tried to ignore the late hour insistently blinking at her from the clock on her desk. She was working on an analysis of proposed capital investments to improve the recently-acquired refinery’s safety. Though Julie had jumped at the promotion opportunity a transfer there presented, she wondered whether she’d made the right move after all. ‘‘I didn’t realize how complicated it was to get and process capital investment information,’’ she thought. Julie was well aware the data were basically educated estimates and wondered if a meteorologist trying to forecast the weather felt the same way—frustrated that the uncertainty could lead to very different actual outcomes. Yet Julie felt pressured to make sure her analysis was correct because of the potential size of the investments and number of people affected. The investments would almost certainly improve employee safety; many of them were basic maintenance activities the former owner had long deferred. However, BO had already spent a great deal of money to acquire the refinery. The stock market could react unfavorably to additional large cash outlays ⇑ Corresponding author. Tel.: +1 254 710 1329; fax: +1 254 710 1067. 1

E-mail addresses: [email protected] (G. Chevis), [email protected] (M. Stuebs). Tel.: +1 254 710 1328; fax: +1 254 710 1067.

0748-5751/$ - see front matter Ó 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.jaccedu.2012.08.001

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so soon after the takeover if there were not cost cuts elsewhere, such as through layoffs. BO employed many people in the Port Arthur area, and several large retirement funds were heavily invested in its stock. ‘‘How should I handle the uncertainties of the estimates in my analysis? Can I make sure I’ve addressed everyone’s concerns? Do I want to feel responsible for laying off, or even firing, hundreds of my neighbors? Or for the injuries or deaths of even a few? Is working on this project going to jeopardize my career or get me fired?’’ These questions plagued Julie as she struggled to turn her attention back to the task at hand. She had the numbers; now she needed to perform the calculations and develop the narrative analysis. 2. A storied past In the late ‘80s and early ‘90s, BO was nothing like the powerful, multi-national corporation Julie joined at graduation 6 years ago. Crippled by the Iranian revolution, the Anglo-Persian oil company was pitied by peers, trading at record lows and forced to cut its dividend. A new group of brash managers attempted to revive the company in the mid-‘90s. John Black stood out; he was a numbers man, and the board liked him. He wanted to grow BO into the largest integrated oil and gas company in the non-OPEC world. John was not fazed by the size of his competition. He took the company on a buying spree and used mergers and acquisitions to propel BO into the big leagues with the likes of Mobil, Exxon, and Chevron. He quickly developed a reputation as an aggressive negotiator and relentless cost cutter, acquiring old companies at cheap prices and then slashing costs to improve efficiency and returns (e.g. ROI). BO made more money on old assets than any other firm. In 5 years, Black managed to quadruple the company’s market value. Just over a year prior to Julie’s arrival, BO had purchased the Oil Company of America (Ocoma) in a $61 billion takeover. Ocoma’s refinery in Port Arthur, Texas was among the prized assets acquired— one of the largest in the United States, employing 1800 people, covering 1200 acres, and converting 430,000 barrels of crude oil a day into high-value petrochemical products and gasoline. Though built in 1934, the age of the refinery was not unusual; the last time a refinery was built in the United States was in 1975. Strict US environmental laws made it less expensive to operate abroad; persistent problems getting community approval made building new refinery capacity in the US troublesome at any cost. The old refineries remained fairly efficient, however. They were also fully depreciated and thus highly profitable. Federal regulators and company officials alike claimed that older refineries did not pose unusual dangers as long as effective safety and maintenance programs were in place. Workers and contractors, however, were wary of the run-down Port Arthur facility. A sense that ‘‘I could die today’’ had pervaded the workforce and was widely considered to be the normal state of affairs by the time BO took ownership. 3. An issue of safety When the aging Port Arthur refinery was under Ocoma’s management, major maintenance upgrades were postponed to reduce costs. By the time it was acquired by BO, the refinery had many problems, including rusted out columns, infrastructure not protected from corrosion, and numerous fire hazards. Of particular importance was the need to consider a number of significant capital investments in the refinery’s isomerization (ISOM) unit. An ISOM unit is used to split raffinate, a low-octane blending feed, into higher-octane components for unleaded regular gasoline. Raffinate is a volatile component of crude oil that is isolated by distillation; an ISOM unit converts it to more usable forms through high-temperature processes in highpressure vessels. Because of these conditions, the unit’s operation is inherently high-risk. Of course, the families of Port Arthur were well aware of the risks of refinery operations generally; many families in the community had been affected by accidents at either the former Ocoma facility or one of the other refineries that operated in the area. Immediately upon her arrival in Port Arthur, Julie assembled a team to interview workers and collect information on the repairs and maintenance the ISOM unit needed. They initially focused on

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simply identifying the issues and planned to gather financial and nonfinancial information in a second round of study. One possibility—previously considered and rejected by Ocoma because of the cost— was replacing the antiquated blowdown drums with more efficient and safer knock-out tank-and-flare technology. Blowdown drums were developed in the 1950s for venting volatile excess liquids and gases into the atmosphere in emergency situations. In the last 20 years, many refineries had installed flares to burn off excess compounds and thus potentially avoid disasters. During her team’s investigation, Julie learned of the need for regular testing of the ISOM system and the importance of gauges and alarms in monitoring the fill level of the tank in which the raffinate was split. Operators routinely ignored existing early-warning alarms, concluding there was ‘‘plenty of room’’ left in the tank after the alarm sounded, and the external physical gauges that could serve as a check on the alarms were either broken or unreadable. Some interviewees wanted BO to dedicate funds to installing modern safeguards: redundant level indicators and alarms, differential pressure indicators, automatic interlocks to prevent overfilling of flammable materials, and emergency pressure-relief valves and system. Finally, an internal memo recommended moving several semi-permanent work trailers further from the ISOM unit to reduce injuries and fatalities if an accident did happen. The more Julie learned about the ISOM unit, the more concerned she became with its condition, the risks placed on the workers, and the potential for extensive legal claims against BO because of the long-running nature of several of the problems. 4. An issue of cost Once the team completed the initial report, Julie sent a copy to Joe Dawson, the head refinery manager. After examining the recommendations, Joe summoned Julie to his office. Julie felt a bit nervous about delivering her first report to the person in charge of the entire refinery, but she squared her shoulders as she took her seat in front of Joe’s desk. ‘‘Good morning, Julie!’’ Joe began. ‘‘You really did a nice job putting together your initial report. Safety is a complex issue, one that is important to all of us.’’ ‘‘Thanks, Joe. I have to say, the refinery infrastructure appears to be in complete decline,’’ Julie confided. ‘‘There are significant reliability and safety issues linked to Ocoma’s past cost-cutting initiatives.’’ Joe leaned back in his chair and crossed his arms. ‘‘I have heard some of the workers are concerned, yes, and I’ve noticed some areas that could be cleaned up and refurbished. I’m not sure it’s as bad as you say, though. After all, I have to come to this place every day, too, but I don’t exactly fear for my life. Tell me more about your team’s recommendations.’’ Julie opened her copy of the report to the section containing the worker interview summaries. ‘‘Yes, some workers expressed a high degree of fear. They worry that a catastrophic accident could happen any time. Sure, from a regulatory perspective BO is in technical compliance, but the standards could soon change. Both the EPA and OSHA are currently considering internal staff proposals for additional regulation. I believe the ground rules could tighten and a significant accident could spur a swift and harsh regulatory response. While I recommend additional safety and maintenance studies, it is imperative we immediately make significant repairs and safety upgrades. We particularly need to replace that blowdown stack with newer technology. A flare system is much safer and more environmentally friendly. I am also very concerned about the workers’ habit of ignoring alarms. If the system isn’t suited for the physical capacity of the equipment, we need to fix the system.’’ ‘‘You raise many good points, and I share your concern for employee safety,’’ Joe replied. ‘‘But you have to understand the estimated cost of the repairs and maintenance you recommend is substantial. And it’s not just the direct costs; production would be severely constrained during the maintenance and repairs.’’ Joe’s voice started to rise as he warmed to his topic. ‘‘Employees would be laid off and the bonus compensation of those remaining—including you and me—would drop.’’ A significant chunk of upper management employee compensation, including a significant portion of Julie’s compensation, was in the form of incentive compensation tied to the facility’s annual financial performance and cost control. Joe continued, ‘‘The Port Arthur economy would suffer. Gas prices nationwide would be affected by even a temporary loss in refinery capacity given how little capacity there is relative to need to begin with! This isn’t really the time to deliver such a negative shock to the national economy. Not to mention that I’ve got to consider corporate’s latest directive to cut costs 25% across the company while also

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maintaining or increasing production! Haven’t you heard Black’s latest motivational speech? ‘We have to continue to look for efficiencies—ways of controlling costs and growing the company.’ We’re square with OSHA and the EPA. What we need to focus on is running our business!’’ Joe suddenly realized he was yelling, stopped in mid-rant, and sighed heavily. ‘‘What priority should be given to maintenance and repair investments? What benefits and savings can be generated? I need more information, Julie,’’ he finished quietly. Though initially taken aback at his outburst, Julie smiled sympathetically at Joe, thinking I don’t envy your job! Aloud, she said, ‘‘It’s also a question of safety, Joe. At what point do you go beyond normal cost-cutting and move into reckless behavior?’’ Joe was silent and flipped through the report. After a minute he looked up and stared hard at Julie. ‘‘Fine. Run the numbers for me. Prepare a capital investment analysis and narrative description of your proposals, and I’ll present it to corporate management and the Board of Directors for approval and funding. It will be up to them to decide.’’ ‘‘Great, Joe. I’ll get to work.’’ Julie realized she’d been dismissed. She left Joe staring blankly at the report on his desk and closed the door softly behind her. She just hoped Joe would be as passionate in his presentation to corporate as he’d been earlier. She clearly needed to put together an informative set of numbers and companion story with relevant information to guide Joe and the Board on the serious safety issues facing the ISOM unit.

5. Numbers tell a story Julie and her team got to work gathering additional information related to the proposed repair and maintenance expenditures. Without these expenditures, BO could refine and sell an estimated 112 million barrels of oil per year at the equivalent of $75 per barrel given BO’s current product mix. The variable costs were approximately $10 per barrel and the fixed costs were around $160 million per year. In addition, Julie’s team gathered information on the probabilities and costs of possible expected accidents. This information could be used to calculate an estimated expected value of the cost of accidents. The post-project operating costs, barrel capacity and potential accident costs depended upon which parts of Julie’s recommendations were funded, so she decided to develop three estimates: one for what she viewed as the minimum investment required to make the ISOM unit function more safely; one for all of the changes apart from switching to flare technology (an intermediate-level proposal); and one to fully fund all the recommended changes, including the flare changeover. In all cases, Julie decided to leave the $75 selling price and $10 variable cost estimates in place. None of the changes were likely to impact variable costs, and selling prices were subject to such uncertainty that Julie thought it best to leave that figure untouched. Barrel capacity, investment costs, and fixed operating costs, however, were another story. To make the minimum required changes would cost $50 million and would take a year to put in place. Such minimal changes would have little impact on continuing capacity or efficiency; during and after the repair process, refinery capacity would remain unchanged. The investment would, however, somewhat reduce the probability and potential costs of an accident. Julie and her team collected data on the likelihood and costs of accidents based on historical data in the industry. This information is included in Table 1. Making all of the recommended changes apart from switching to flares would cost approximately $70 million and would likely result in a year of reduced capacity of roughly 80 million barrels. Julie expected these changes to improve efficiency enough to increase post-project annual production to 117 million barrels. Once the systems were online, the net annual fixed costs would decrease slightly, to approximately $155 million. The investments would also reduce the probabilities and projected costs of expected accidents. If the Board would agree to fund the flare technology, Julie estimated the upfront cost would be $150 million. As it was a larger project, the reduced capacity downtime would stretch to 2 years. The changes, however, would result in additional efficiency improvements. Given the importance of this particular safety improvement, BO would also be able to reduce insurance costs significantly once the system came online. Post-implementation annual capacity would be roughly 120 million barrels,

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G. Chevis, M. Stuebs / J. of Acc. Ed. 30 (2012) 307–324 Table 1 Julie’s spreadsheet. Beyond Oil, Inc. Port Arthur ISOM unit repairs and maintenance data Initial investment Complete funding

$ 150,000,000 $ 70,000,000 $ 50,000,000 15

Midrange funding Minimum funding Depreciable life of investment assets Operations information Original operations

With capital expenditures

Costs Sales Price per barrel Variable costs per barrel Fixed costs

Costs $75 Sales price per barrel $10 Variable costs per barrel $160,000,000 Fixed costs Complete funding Midrange funding Minimum funding

Capacity/production (barrels)

112,000,000

Expected accident cost

Probability Cost

Significant Accident/event Moderate Accident/event Minor Accident/event No accident

4.00% 7.00% 4.00% 85.00%

Other information Income tax rate Hurdle (discount) rate

$ 80,000,000 $ 60,000,000 $ 40,000,000 0

$75 $10 $120,000,000 $155,000,000 $160,000,000

Capacity/production (barrels) Year 1, midrange and complete funding Year 2, midrange funding Year 2, complete funding Thereafter Complete funding Midrange funding Minimum funding Expected accident cost Complete funding Significant accident/event Moderate accident/event Minor accident/event No accident Midrange funding Significant accident/event Moderate accident/event Minor accident/event No accident Minimum funding Significant accident/event Moderate accident/event Minor accident/event No accident

80,000,000 117,000,000 105,000,000 120,000,000 117,000,000 112,000,000 Probability Cost 1.00% 2.00% 1.00% 95.00%

$ 40,000,000 $ 30,000,000 $ 20,000,000 0

1.00% 4.00% 1.00% 94.00%

$ 50,000,000 $ 40,000,000 $ 30,000,000 0

1.00% 4.00% 1.00% 94.00%

$ 80,000,000 $ 60,000,000 $ 40,000,000 0

40% 10%

annual fixed costs would drop to around $120 million, and the projected probabilities and costs of expected accidents would go down as well. Julie estimated all of the capital investments would have a useful life of 15 years with no salvage value. For ease of comparison and analysis between alternatives, Julie conservatively assumed all capital investment outlays occurred and began to be depreciated at the same time (i.e., time 0) even though complete installation of some considered alternatives occurred after the start of capital investment outlays (i.e., time 0).2 2 Assuming that all capital investment outlays occur at the start of the project is more conservative in a present-value sense. This practice increases the present value of capital investment cash outflows, making it more difficult for a project to achieve a positive NPV.

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Julie input the information she and her team gathered into a spreadsheet (Table 1) so she could calculate the net present value (NPV) and payback period of the different funding options. She noted that it was BO’s policy for tax purposes to depreciate capital investments using the straight-line (SL) method. In addition, BO’s marginal tax rate (federal, state, and local—combined) was about 40%; the hurdle (discount) rate was 10% (after tax) for all capital expenditures. In evaluating potential capital investments, BO would only invest in capital projects with a positive NPV within 5 years to satisfy certain profitability thresholds and would only invest in capital projects with an unadjusted payback period of 5 years or less. BO used this horizon as a ‘‘rule of thumb’’ to deal with the riskiness associated with the future cash-flow estimation process. 6. As many questions as answers Julie rubbed her temples as she tried to compose her thoughts and prepare her analysis. She considered other facts that were relevant but did not quite fit into her spreadsheet. Joe Dawson had a portion of his pay tied to the refinery’s performance, and Chairman and CEO John Black had millions at stake because of his outstanding options and restricted stock grants3. Both men were likely to be fired if financial performance was unsatisfactory, and in any event the average tenure of those positions was less than 7 years. Julie suspected they had little interest in making capital investments in safety and were instead focused on short-term financial performance. Indeed, they could always decide to complete none of her proposed repair-and-maintenance activities and instead continue Ocoma’s policy of deferring safety expenditures. BO’s general counsel had pointed out that BO was observing all existing OSHA and EPA regulations. ‘‘Our refinery isn’t the only US refinery—or even the only Port Arthur refinery—with maintenance issues,’’ he said during his interview. ‘‘All US refineries are old. And government standards are moving targets that change with the political climate; BO should wait for the regulators before making any major changes. Even if there were an accident, we would have an excellent case against any criminal charges because we are in compliance with existing standards. And I think we’d have a good shot against any civil claims, too. To my knowledge there’s no evidence we’ve been negligent.’’ A labor union organizer Julie interviewed had expressed conflicting concerns. ‘‘I’m of course worried about safety issues that could injure workers, especially if those issues arise because of negligence. My guys tell me they’re worried about conditions at the refinery, sure. Employees know these are demanding jobs and they accept the risks when the company is on the up-and-up. But I also have to think about the potential for layoffs. These folks want to work. They need these jobs.’’ Then there were the other issues confronting BO, including a temporary shutdown of their pipeline in Alaska, allegations of attempted manipulation of the natural gas market, and construction delays on the newest deep-water drilling platform in the Gulf of Mexico. Julie was not sure if such issues would make the Board more or less favorable to the idea of spending millions of dollars on one ISOM unit, even if it was at the company’s largest refinery. As her thoughts swirled, Julie’s stress mounted. What were her responsibilities in this situation to her boss, the Board of Directors, and the shareholders of BO? What about her fellow workers and her neighbors in the surrounding community? Would her analysis affect her job security and ability to provide for her family? Revelation of her role in job losses if she was successful in getting the changes made—or her role in a catastrophic accident if she was not—would certainly affect her relationships with everyone and could cause her husband and children to be ostracized. Julie shook her head to clear it. She could not think about all of that now. She had to get back to work. 7. Case requirements Put yourself in Julie Wilson’s shoes and prepare her report to guide BO’s decision on which investments to make in the ISOM unit. Addressing the following questions will assist you in 3 Restricted stock grants are a form of incentive compensation tied to financial and stock price performance. They are grants of shares of stock subject to forfeiture until vested by continued employment and subject to restrictions on sale.

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constructing your report to be delivered to Joe Dawson and ultimately to be presented to the Board of Directors. 1. What are Julie’s responsibilities in this situation? NOTE: You can apply the general standards in the IMA Statement of Ethical Professional Practice (available at: http://www.imanet.org/PDFs/Statement%20of%20Ethics_web.pdf and also printed in the Appendix A) to help you identify specific responsibilities for Julie in this situation. 2. Complete the net present value (NPV) analysis and payback-period analysis required for Julie’s report and prepare a discussion of your findings. (Hint: Remember to use BO’s required 5-year time horizon for your analyses.) Based solely on the economics, what course of action should Julie recommend? 3. Complete the narrative required for Julie’s report, incorporating a qualitative, strategic assessment of the impact of your recommended option above. Be sure to include the following in your discussion: a. What benefits and harms result and to whom? b. What rights are being exercised (denied) and by (to) whom? c. Should these impacts modify or change Julie’s economic recommendation? How? 4. What other information should Julie gather that could affect her analysis? 8. Teaching notes 8.1. Overview and educational objectives Julie Wilson is an accountant at the large oil and gas firm Beyond Oil, Inc. She needs to complete a quantitative and qualitative analysis of proposed capital investments in safety improvements at the ISOM unit of the recently-acquired Port Arthur, Texas refinery at which she works. Julie sees that the improvements are overdue and necessary, but her supervisor and the Board of Directors are concerned about financial-performance impacts, layoffs and a stock price decline that could result from a large cash expenditure so soon after the acquisition. In addition, the refinery is currently in compliance with all applicable regulations and is a major employer in the area. Students complete the case as if they were Julie. The case questions prompt students to consider their professional/ethical responsibilities, the economic cost-benefit effects of alternatives, and the impact of their recommendation on various stakeholders. This case has two related learning objectives. First, students become aware of their responsibilities and the complex issues they may confront in capital budgeting decisions. Second, students apply quantitative capital budgeting tools (NPV and payback-period analyses) under conditions of uncertainty as part of a larger decision-making process; they integrate knowledge from managerial accounting with qualitative and ethical analyses of responsibilities, including the professional responsibilities in the IMA Statement of Ethical Professional Practice. They practice making decisions with ethical dimensions and implications in situations with uncertainty, conflicting incentives, and permissive legal guidance. Because the case facilitates integration of knowledge across domains, it can be used to address application, analysis, synthesis, and evaluation-level goals of Bloom’s cognitive taxonomy of learning (Bloom, Engelhart, Furst, Hill, & Krathwohl 1956). Our case complements existing capital-investment-decision cases, such as Zeller and Stanko (2008) information technology (IT) example, by incorporating elements of uncertainty. It also increases students’ awareness of Blocher (2009) argument that cost management is a tool to help organizations succeed, rather than simply a way to keep score, direct attention, and solve problems. Perhaps more importantly, this case provides an opportunity to integrate ethics into a traditional management accounting course. Ethics, professional identity, and professional ideals are foundational components of accounting education (Wilkerson, 2010). Morality is among the important skills identified by Bots, Gorenland, and Swagerman (2009) that managerial accountants should have at graduation, but Fleming, Romanus, and Lightner (2009) find that professional context—in that study, Audit vs. Corporate—influences students’ moral reasoning. This supports Hurtt and Thomas (2008) point that instructional cases and resources are needed to integrate ethics across the accounting curriculum. Like Stuebs (2008) and Haywood and Wygal (2009), our case is such a resource.

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8.2. Implementation guidance We have written this case for students in an advanced undergraduate or graduate managerial or cost accounting course. It should be used after students have practiced NPV and payback period capital investment techniques. The case builds upon these basic knowledge and comprehension skills by requiring students to integrate capital investment analysis into a broader decision-making process that considers responsibilities in the presence of competing interests and incentives. Because the case integrates capital investment analyses within a larger analysis and considers professional responsibilities (in particular, the IMA Statement of Ethical Professional Practice) in the presence of incentives, it can be used in an accounting ethics course as well. The case can also be simplified and adapted for use in lower-level managerial accounting classes. For example, instructors can remove one or two of the investment options or some of the uncertain estimates; this would simplify the NPV computations. The case can be discussed in a 75-min session if the students have prepared the quantitative analysis ahead of time and that portion of the discussion is focused on resolving student questions or difficulties. If a significant amount of time will be spent on the calculations themselves, the case could be used in two sessions: one focused on the quantitative analysis alone and one integrating it into the overall narrative. We use the discussion to increase student understanding that there are different approaches to identifying responsibilities, reconciling competing interests, and making decisions. We also stress that managerial accounting decisions involve much more than consideration of quantitative cost-benefit capital investment analyses, a student sentiment we have (anecdotally) found to be exacerbated by standard texts’ reliance on shorter, end-of-chapter problems. Such decisions also involve awareness and fulfillment of professional and corporate responsibilities, which in turn protects the public trust of the accounting profession. We present additional questions and resources to prompt thoughtful discussion in the recommended solution to question 4, below. The case is inspired by events at British Petroleum’s (BP’s) Texas City refinery. In 1999, BP took over the refinery when it acquired Amoco. In March 2005, an explosion in the refinery’s isomerization unit killed 15 employees and injured over 170. The explosion served as a precursor to BP’s Deepwater Horizon explosion and oil spill in the Gulf of Mexico in 2010. Both resulted in part from a lack of maintenance and investment in safety. If instructors feel that the case is thinly veiled and mirrors BP events too closely and that prior student knowledge of BP events could bias student case responses, we encourage instructors to clearly mention up front that the case was patterned after events at BP and reinforce the point that prior views about BP’s actions should not influence their current case solutions. Several excellent resources discuss the Texas City disaster and can bring an added dimension of reality to the case and class discussion. Although the case is set at the initial acquisition, when BP would have evaluated the need for safety investments, the resources provide evidence of what can happen when such investments (and responsibilities) are neglected.  Dismal Refinery Safety and Chemical Records, ABC News: (http://abcnews.go.com/Blotter/hydrofluoric-acid-risk-oil-refineries/story?id=12985686&page=1). The 2011 story and 6-min video document problems and issues with chemicals and safety at numerous refineries in the United States and the growing need for repairs and maintenance investments to improve refinery safety.  Anatomy of a Disaster, Chemical Safety Board: (http://www.safetyvideos.gov/videoroom/detail.aspx?vid=16&F=0&CID=0&pg=1&F_All=y; http://www.youtube.com/watch?v=XuJtdQOU_Z4). The 55-min video is a summary of the Chemical Safety Board’s investigation of the 2005 Texas City explosion. It includes thorough diagrams of the Texas City ISOM unit and an analysis of the factors that contributed to the disaster.  ‘‘The Explosion at Texas City,’’ 60 Minutes, CBS, October 26, 2006: (http://www.cbsnews.com/stories/2006/10/26/60minutes/main2126509.shtml). The transcript and video present the original, as-aired analysis of the Texas City disaster. A related website put together by Brent Coon Associates of Beaumont, Texas (http://www.texascityexplosion.com/60mins_09) includes a video link and additional resources, including evidence releases, trial highlights, and a news video library.  ‘‘The Spill,’’ Frontline, PBS: (http://www.pbs.org/wgbh/pages/frontline/the-spill/). The 54-min program investigates the trail of accidents, spills, violations and other problems created by BP before

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the 2010 Deepwater Horizon disaster in the Gulf of Mexico., including a segment on the Texas City explosion. The website includes many other resources related to the Deepwater Horizon and BP.  ‘‘BP to Sell Two Oil Refineries,’’ The Wall Street Journal, February 2, 2011, B1: The article reports recent BP activities, including its decision to sell the Texas City refinery. 8.3. Evidence regarding case efficacy We recommend using this case study with undergraduate or graduate managerial accounting and accounting ethics courses. We have used these case issues in an accounting ethics class with good results, though we did not collect formal feedback. Students responded positively to the application, extension and integration of managerial accounting analyses used to make decisions. Students found it easy to identify with Julie’s situation and consider the situation from her perspective. The resources on B.P.’s Texas City explosion also added realism to the case for students. In general, students found the case interesting and challenging. 8.4. Recommended solutions 8.4.1. What are Julie’s responsibilities in this situation? Accountants such as Julie have a responsibility to build trust by faithfully reporting information. According to the IMA Statement of Ethical Professional Practice, a commitment to the principles of honesty, fairness, and objectivity helps Julie fulfill reporting responsibilities when making reporting decisions. To adhere to the standard of credibility, Julie must report trustworthy, accurate, and objective information about the costs and benefits of alternatives. Julie must include both quantitative and qualitative information and disclose the nature of any uncertainties in her analysis to adhere to the standards of competence and integrity. Julie should uphold the standard of confidentiality and discuss any concerns about the decision-making process with her supervisor, Joe Dawson. If she is not satisfied with the answers provided by Joe, she should address her concerns to his supervisor and on up through the organization to the board of directors. If none of these parties can satisfactorily answer or address her concerns about workplace safety, and Julie has exhausted all of the options offered to her by BO’s internal policies on ethical behavior, she should consider resigning from her job and contacting her attorney about her legal responsibilities. It is not clear that Julie should communicate her concerns to regulators or parties outside of BO, because BO is not currently in violation of any laws. 8.4.2. Complete the net present value (NPV) analysis and payback period analysis required for Julie’s report and prepare a discussion of your findings. Based solely on the economics, what course of action should Julie recommend? According to BO’s capital investment requirements, Julie should recommend that BO do nothing and continue the status quo of deferring maintenance. As illustrated in Appendix B, none of the investment alternatives have a positive NPV after 5 years: Minimum = $32,663,469; Midrange = $609,154,751; Complete = $745,044,509. None of the investment alternatives have a payback period within 5 years: Minimum = 10.93 years; Midrange = 7.42 years; Complete = 6.66 years. An Excel file containing the complete solution is available from the authors on request. All are constructed relative to the status quo of doing nothing. Instructors have the opportunity to discuss why BO might have a relatively short time horizon for a return on long-lived assets. Possible reasons include: increased estimation errors with extended forecasts; management and investors focused on short-term financial returns; relatively short management tenure; and managerial compensation tied to financial performance. These can result in a focus on short-term returns, deferring maintenance investments for somebody else to handle. Ignoring the 5-year requirement, funding the complete repairs including the blowdown stacks has the shortest payback period (6.66 years) and the highest NPV over the 15-year life of the proposed project ($570,010,592 = 745,044,509 + [344,680,000  PVA(10, 10%)  PV$1 (5, 10%)] = 745,044,509 + [344,680,000  6.144  0.621]). The 15-year NPVs for the minimum and midrange investment alternatives are $15,214,863 and $168,503,650 respectively. Since the complete investment alternative has an estimated NPV that is $570,010,592 higher than the ‘‘do nothing’’ option and a

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relatively low payback period (i.e., 6.66 years is close to 5 years), perhaps BO should reconsider its 5-year capital investment benchmarks and make the safety investments. 8.4.3. Complete the narrative required for Julie’s report, incorporating a qualitative, strategic assessment of the impact of your recommended option above. What benefits and harms result and to whom? What rights are being exercised (denied) and by (to) whom? Should these impacts modify or change Julie’s economic recommendation? How? Students will likely have a variety of answers to this portion of the analysis, making this portion of the discussion especially lively. Note that the impacts will change depending on the decision made and the alternative chosen. Here we identify a potential solution to the impact of the decision to make all repairand-maintenance investments including the investment in flare technology (i.e., the complete option). 1. Possible parties benefitting: BO management (e.g., Joe Dawson and John Black) and shareholders build trust with employees and the community and may protect the refinery from potential future litigation costs. BO shareholders benefit in the long-run from improved financial performance and reduced safety risks from the safety investments. Employees and the Port Arthur community benefit from additional steps and investments to protect their health and safety. The Port Arthur economy can benefit and be somewhat sustained during the safety investment process if constructionrelated employment opportunities are found. 2. Possible parties harmed: BO management (e.g., John Black, Joe Dawson, Julie Wilson) is harmed by the short-term decline in profitability and performance-based pay. They currently benefit financially if the changes are not made. BO shareholders may be harmed by the short-term decline in profitability and may be harmed by a decline in share price. Customers may have to get petroleum products from new suppliers. To alleviate this harm, BO may work to source customer needs from refinery facilities at other locations. Suppliers may have a temporary decline in business. To alleviate this harm, BO may work with suppliers to meet the supply needs for the shifted, increased capacity at other refinery locations. Employees may be harmed by temporary layoffs, lost wages, and job uncertainty. To alleviate this harm, BO may work to find construction-related employment opportunities for employees during the safety investment process. The Port Arthur Community may be harmed from the economic impacts during the safety-investment process. 3. Possible parties exercising rights: Owners and managers are exercising their legal/contractual right to make operations and capital investment decisions for BO. Julie Wilson is exercising her professional right as a managerial accountant to decide how best to accurately report information and analyses. Of course, with both of these rights come responsibilities. Management has a fiduciary responsibility to stakeholders. Julie has professional reporting responsibilities. 4. Possible rights denied: Steps have been taken to protect the natural right of employees and the Port Arthur community to a safe work place. The right of the government/citizens to have the spirit of safety laws obeyed is fulfilled. However, the nature and extent of employees’ right to safety is a subjective issue and open to discussion. Students should also contrast short-term economic impacts with potential long-term safety and health impacts and tangible financial impacts with intangible trust and relationship impacts. Tangible financial impacts are the primary focus of managerial accounting analyses, particularly as explained in traditional accounting texts. The short-run economic costs of safety investments are more transparent and estimable. Intangible trust and relationship impacts, though important, are often ignored because they are more difficult to estimate and quantify. For example, it is difficult for Julie to quantify the potential harms to employees and the community from insufficient health and safety-related precautions. These costs, however, can be just as or even more substantial in the long run than the short-run economic costs. 8.4.4. What other information should Julie gather that could affect her analysis? Students will again likely have a variety of answers to this portion of the analysis. This note first answers the case question then extends the question by considering why Julie should want this additional information.

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317

1. What other information should Julie gather? Possibilities include: a. Materiality: The case does not address materiality, providing the opportunity to bring concepts traditionally associated with financial reporting into the discussion. Julie could find out whether the negative NPVs from the main analysis would be material either to the refinery or to BO overall. Given the uncertainties in the NPV analysis, BO may wish to pursue a safety project with an immaterially negative NPV. Uncertainty and materiality are also tied to BO’s 5-year evaluation horizons. Students could explore the certainty and materiality of cash flows beyond the 5-year evaluation horizon. b. Sensitivity of estimates: Students could perform sensitivity analyses to determine which estimates drive the overall NPV results. The 2-year reduction in capacity, for example, is a major contributor to the negative NPV of the complete funding option. Julie could gather additional information to refine that estimate. Another option is to change the sale price considering the high value-added of the product coming out of the ISOM unit and the tendency of oil prices to increase over time. The suitability of straight-line depreciation for tax purposes and the high marginal tax rate are also areas of potential estimation error. Accelerating the recovery of the depreciation tax shield would increase the NPV for all funding levels, and Julie could research the possibility of special tax write-offs or credits from making such investments. Students should be able to identify and look into these depreciation options. Note that straight-line depreciation is used in the case to simplify calculations of cash flows, present values and payback periods. Instructors can relax this simplification and introduce accelerated depreciation to add complexity to the calculations. c. Likelihood and cost of accidents: Although some information is already available, Julie could gather additional information on the likelihood and costs of accidents, including legal and reputational costs, given the difficulties in identifying and quantifying such information. This is a particularly good opportunity to discuss the real-life case of the BP Texas City explosion, the Deepwater Horizon accident, the Exxon Valdez spill and other similar events. To facilitate discussion see the resources provided above; without a changeover to flare technology, it is unclear that BP could have avoided the Texas City disaster. d. Regulatory costs: Julie could investigate the potential for changes to the existing regulatory requirements. This information could be incorporated into the NPV sensitivity analyses described above. 2. Why should (additional) information be gathered? This question requires students to consider how ethical considerations underlie the decision-making process. The discussion should lead students to recognize that information is gathered to identify responsibilities and ethical decisions and moral actions4 are made to fulfill those responsibilities. Multi-criteria decision tools provide approaches for handling multi-criteria decision analyses and reconciling competing responsibilities (Blocher, Stout, & Cokins 2010). Answering questions on what responsibilities a company has for investing in safety and how these responsibilities can be met is an interesting exercise. The objective is to help students develop good judgment even in conditions of subjectivity and uncertainty. One way to start the discussion is by asking students to research real-world examples involving safety investments and failures. We list possibilities and available materials below. a. Examples involving customer safety: i. The Tylenol recall case: In the Chicago area in late 1982, seven people died after consuming Tylenol capsules that had been laced with potassium cyanide. Johnson & Johnson (J&J) (the parent company) issued warnings to hospitals and distributors, halted Tylenol production and advertising, and recalled 31 million bottles of Tylenol products with a retail value of over

4 Although the two terms can be and often are used interchangeably, ethics relates to thought while morality relates to action. ‘‘Morality refers to the standards of behavior by which people are judged. . .Ethics. . .encompasses the system of beliefs that supports a particular view of morality’’ (Hosmer, 2008, p. 99, emphasis added).

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ii.

iii.

b.

c.

$100 million. J&J received positive media coverage for sacrificing profits to protect consumer safety (http://en.wikipedia.org/wiki/Chicago_Tylenol_murders). Ford Pinto case: The Ford Pinto fuel tank was susceptible to puncture in rear-end collisions, resulting in deadly fires from spilled fuel. Ford was criticized for comparing the cost of an $11 fuel tank repair to the value of a human life in analyses it performed prior to production. A brief, 2-min video demonstrating the results of a rear-end Ford Pinto car crash is available at: http://www.youtube.com/watch?v=lgOxWPGsJNY. Toxic toys: NOW’s story ‘‘Toxic Toys’’ (http://www.pbs.org/now/shows/412/transcript.html) reports on the use and regulation of phthalates, potentially harmful, cancer-causing chemicals used to manufacture plastic toys. The video (http://www.pbs.org/now/shows/412/video.html) segment from about the 9:00 min mark to the 11:30 min mark compares the European precautionary approach, avoiding possible harmful actions until proven safe, to the US reactionary approach, allowing actions until they are proven harmful. The U.S. Congress is considering the Safe Chemicals Act of 2012 (http://www.saferchemicals.org/safe-chemicals-act/index.html) which would implement a more precautionary approach to regulating the use of such chemicals (http://www.saferchemicals.org/toxic-chemicals/phthalates.html). Example involving community and society safety—Erin Brockovich: Erin aids in investigating Pacific Gas & Electric’s (PG&E’s) use of hexavalent chromium VI in a Hinkley, California facility and the safety and health effects on members of the surrounding community. Chapter 19 and Chapter 29 from the movie’s DVD present interactions between PG&E lawyers and Erin Brockovich and plaintiff lawyers which can spur class discussion. Example involving employee safety—NFL concussions: Recent deaths of former players (e.g., Junior Seau and Dave Duerson) have drawn attention to the possible link between football and chronic traumatic encephalopathy (CTE) and resulted in lawsuits against the national football league (NFL) by former players (http://www.bendbulletin.com/article/20120608/NEWS0107/ 206080399/).

For each example, students should recognize the importance of identifying what safety responsibilities exist for companies and consider how those responsibilities can be met. Students could view the issues from multiple perspectives, including profit maximization, legal compliance, and moral responsibility. Topics for consideration in each area include: a. Profit-maximization responsibility. The company’s responsibility is limited to maximizing revenues and minimizing costs. Several cost characteristics and dimensions warrant consideration in a cost-benefit analysis.  Costs of Quality (Safety): Students can identify and classify safety costs into costs of quality (COQ) categories. Examples of costs of conformance include investments in the flare technology (a prevention cost) and investments in repairing and replacing monitoring mechanisms (appraisal costs). Examples of costs of nonconformance include employee injuries and foregone production (internal failure costs) and costs related to a damaged public reputation (an external failure cost). Notice that these costs include both out-of-pocket costs as well as opportunity costs. An important conclusion is that the central theme of quality improvement can be applied to safety investments. Taking responsibility for making investments in prevention drives even larger savings in quality-related failures and appraisal efforts. This complements the precautionary approach in the Toxic Toys example above.  Short-term vs. long-term: Tangible, short-term financial impacts are the primary focus of managerial accounting analysis, particularly as explained in traditional accounting texts. Intangible, longer-term impacts on trust and relationships are often easily ignored because they are more difficult to estimate and quantify, however these costs can be just as or even more substantial in the long run. An important part of ethical development is realizing the value of building and maintaining trust.

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319

 Value/cost of human life: Whether you should and how you could value a human life are interesting questions and ones that Ford addressed in its Pinto cost-benefit analysis. From an economic, profitmaximizing perspective, humans/employees should be valued at their marginal productivity. b. Legal compliance responsibility. The company’s responsibility is limited to legal compliance. The underlying assumption is that the law contains and expresses the collective moral standards of society. As a result, following safety laws fulfills safety responsibilities. Is following the law enough? Several legal characteristics warrant consideration.  The law is incomplete: The law is likely an incomplete collection of society’s ethical and moral standards for a number of reasons in the legal formation process. For example, political and special interest influences can bias legal formation, as with legally-permitted slavery in the pre-Civil War United States. Business responsibilities for workers and safety may extend beyond minimal compliance with prevailing law.  Type of compliance: How should one follow the law? Legal compliance involves and requires judgment. Compliance should involve meeting and fulfilling the principle underlying the law, not just its technical form (i.e., substance over form).  Regulatory compliance costs: A regulatory and monitoring solution to safety and other compliance issues adds an additional layer of costs (monitoring and compliance costs) while possibly reducing and removing other social costs (externalities). For example, the costs of Sarbanes–Oxley (SOX) and the PCAOB aim to substitute regulation and monitoring costs for the costs imposed generally on a less-informed market by low-quality audits and poor internal controls.  Moral responsibility. A company builds trust and sustainable relationships by identifying, accepting and fulfilling responsibilities. For example, J&J built trust and relationships by identifying, accepting, and fulfilling responsibilities beyond profits or legal responsibilities. Several moral dimensions warrant consideration:  Trust: Meeting and fulfilling responsibilities builds trust. Limiting responsibilities to maximizing corporate profit or merely technically complying with regulations risks damaging and destroying trust and relationships. Trust can be easy to damage but difficult to restore.  Disclosure: Does disclosure of safety issues and risks fulfill safety responsibilities? For example, if the NFL informs players and recruits of the risks repeated concussions pose to their future health and safety; does this fulfill the NFL’s responsibilities to employees? Acknowledgments We would like to thank the reviewers, associate editor, and editor (David E. Stout) for very helpful suggestions that improved the paper. All remaining errors are our own.

Appendix A. IMA Statement of Ethical Professional Practice http://www.imanet.org/PDFs/Statement%20of%20Ethics_web.pdf. Members of IMA shall behave ethically. A commitment to ethical professional practice includes overarching principles that express our values, and standards that guide our conduct.

A.1. Principles IMA’s overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility. Members shall act in accordance with these principles and shall encourage others within their organizations to adhere to them.

A.2. Standards A member’s failure to comply with the following standards may result in disciplinary action.

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A.2.1. Competence Each member has a responsibility to: 1. Maintainanappropriatelevelofprofessionalexpertisebycontinuallydevelopingknowledgeandskills. 2. Perform professional duties in accordance with relevant laws, regulations, and technical standards. 3. Provide decision support information and recommendations that are accurate, clear, concise, and timely. 4. Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. A.2.2. Confidentiality Each member has a responsibility to: 1. Keep information confidential except when disclosure is authorized or legally required. 2. Inform all relevant parties regarding appropriate use of confidential information. Monitor subordinates’ activities to ensure compliance. 3. Refrain from using confidential information for unethical or illegal advantage. A.2.3. Integrity Each member has a responsibility to: 1. Mitigate actual conflicts of interest, regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts. 2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. 3. Abstain from engaging in or supporting any activity that might discredit the profession. A.2.4. Credibility Each member has a responsibility to: 1. Communicate information fairly and objectively. 2. Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations. 3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law. A.3. Resolution of ethical conflict In applying the Standards of Ethical Professional Practice, you may encounter problems identifying unethical behavior or resolving an ethical conflict. When faced with ethical issues, you should follow your organization’s established policies on the resolution of such conflict. If these policies do not resolve the ethical conflict, you should consider the following courses of action: 1. Discuss the issue with your immediate supervisor except when it appears that the supervisor is involved. In that case, present the issue to the next level. If you cannot achieve a satisfactory resolution, submit the issue to the next management level. If your immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with your superior’s knowledge, assuming he or she is not involved. Communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate, unless you believe there is a clear violation of the law. 2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics Counselor or other impartial advisor to obtain a better understanding of possible courses of action. 3. Consult your own attorney as to legal obligations and rights concerning the ethical conflict.

***

**

*

0

16,173,770,830

Discounted no R&M net cash flows

No repairs net present value

ACCIDENT

745,044,509

15,428,726,321

150,000,000

1.000

150,000,000

3,327,504,132

0.826

4,026,280,000

720,000

4,023,000,000

4,000,000

0.40).

<0, therefore do not do complete repairs and maintenance investments

2,773,890,909

0.909

3,051,280,000

+ ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)  (1

Tax Rate)].

 CostNO

FC)  (1

ACCIDENT

VC) * Units

(ProbabilityNO

[((SP

Initial Investment/15  0.40.

Incremental complete R&M net present value

Complete repairs net present value

Discounted minimal R&M net cash flows

Present value factors

Complete R&M net cash flows

720,000

3,048,000,000

Estimated accident cost***

4,000,000

Operating income**

150,000,000

3,694,567,493

0.826

4,470,426,667

1,440,000

4,470,000,000

1,866,667

< 0, therefore do not do midrange repairs and maintenance investments

2,752,206,061

0.909

3,027,426,667

Depreciation tax shield*

Initial repairs and maint. investments

Option: Complete R&M investments

609,154,751

Midrange repairs net present value

Incremental midrange R&M net present value

-70,000,000

15,564,616,080

Discounted minimal R&M net cash flows

70,000,000

1.000

Midrange R&M net cash flows

Present value factors

1,440,000

3,027,000,000

Estimated accident cost

1,866,667

***

3,529,895,317

0.826

4,271,173,333

2,160,000

4,272,000,000

1,333,333

3,526,115,702

0.826

4,266,600,000

5,400,000

4,272,000,000

2

< 0, therefore do not do minimum repairs and maintenance investments

3,882,884,848

0.909

4,271,173,333

Operating income**

70,000,000

32,663,469

16,141,107,362

50,000,000

1.000

50,000,000

Depreciation tax shield*

Initial repairs and maint. investments

Option: Midrange R&M investments

Incremental minimal R&M net present value

Minimal repairs net present value

Discounted minimal R&M net cash flows

Present value factors

Minimal R&M net cash flows

2,160,000

4,272,000,000

Estimated accident cost***

1,333,333

Operating income**

Initial repairs and maint. investments

3,878,727,273

0.909

4,266,600,000

5,400,000

4,272,000,000

1

Depreciation tax shield*

50,000,000

1.000

Present value factors

Option: Minimal R&M investments

0

0

No R&M net cash flows

Estimated accident cost***

Operating income**

Option: No repairs and maint. investment

Comparative analysis of each option

Net present value (NPV) analysis

Beyond oil repairs and maintenance investment analysis

Appendix B. Quantitative analysis

3,464,522,915

0.751

4,611,280,000

720,000

4,608,000,000

4,000,000

3,358,697,721

0.751

4,470,426,667

1,440,000

4,470,000,000

1,866,667

3,208,995,743

0.751

4,271,173,333

2,160,000

4,272,000,000

1,333,333

3,205,559,730

0.751

4,266,600,000

5,400,000

4,272,000,000

3

3,149,566,286

0.683

4,611,280,000

720,000

4,608,000,000

4,000,000

3,053,361,565

0.683

4,470,426,667

1,440,000

4,470,000,000

1,866,667

2,917,268,857

0.683

4,271,173,333

2,160,000

4,272,000,000

1,333,333

2,914,145,209

0.683

4,266,600,000

5,400,000

4,272,000,000

4

2,863,242,079

0.621

4,611,280,000

720,000

4,608,000,000

4,000,000

2,775,783,241

0.621

4,470,426,667

1,440,000

4,470,000,000

1,866,667

2,652,062,597

0.621

4,271,173,333

2,160,000

4,272,000,000

1,333,333

2,649,222,917

0.621

4,266,600,000

5,400,000

4,272,000,000

5

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322

Beyond oil repairs and maintenance investment analysis Net present value (NPV) analysis Minimum funding incremental analysis 0

2

3

4

5

1,333,333 0 3,240,000

1,333,333 0 3,240,000

1,333,333 0 3,240,000

1,333,333 0 3,240,000

1,333,333 0 3,240,000

50,000,000 1.000

4,573,333 0.909

4,573,333 0.826

4,573,333 0.751

4,573,333 0.683

4,573,333 0.621

Discounted minimal R&M incremental cash flows

50,000,000

4,157,576

3,779,614

3,436,013

3,123,648

2,839,680

Minimum funding incremental present value

32,663,469

<0, Therefore do not do the minimum funding

50,000,000

Minimal R&M incremental cash flows Present value factors

Payback period

10.933

Years > 5 years, therefore do not do the minimum funding



[(ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)MINIMUM FUNDING (ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)NO FUNDING]  (1 0.40). *(Initial Investment  15)  0.40. **[((SP VC)  Units FC)MINIMUM FUNDING ((SP VC)  Units FC)NO FUNDING]  (1 Tax Rate).

Beyond oil repairs and maintenance investment analysis Net present value (NPV) analysis Midrange funding incremental analysis 0 Initial repairs and maint. investments Depreciation tax shield* Operating income** Estimated accident cost** Midrange R&M incremental cash flows Present value factors

70,000,000 1.000

Discounted midrange R&M incremental cash flows

70,000,000

Midrange funding incremental net present value

609,154,751

Payback period 

1

2

3

4

5

1,866,667 1,245,000,000 3,960,000

1,866,667 198,000,000 3,960,000

1,866,667 198,000,000 3,960,000

1,866,667 198,000,000 3,960,000

1,866,667 198,000,000 3,960,000

1,239,173,333 0.909

203,826,667 0.826

203,826,667 0.751

203,826,667 0.683

203,826,667 0.621

1,126,521,212

168,451,791

153,137,991

139,216,356

126,560,324

70,000,000

7.423

<0, Therefore do not do the midrange funding Years > 5 years, therefore do not do the midrange funding

[(ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)MIDRANGE FUNDING (ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)NO FUNDING]  (1 0.40). *(Initial Investment  15)  0.40. **[((SP VC)  Units FC)MIDRANGE FUNDING ((SP VC)  Units FC)NO FUNDING]  (1 Tax Rate).

G. Chevis, M. Stuebs / J. of Acc. Ed. 30 (2012) 307–324

1

Initial repairs and maint. investments Depreciation tax shield* Operating income** Estimated accident cost**

Beyond oil repairs and maintenance investment analysis Net present value (NPV) analysis Complete funding incremental analysis 0

Complete R&M incremental cash flows Present value factors Discounted midrange R&M incremental cash flows

150,000,000 1.000 150,000,000

Complete funding incremental net present value

745,044,509 6.658

2

3

4

5

4,000,000 1,224,000,000 4,680,000

4,000,000 249,000,000 4,680,000

4,000,000 336,000,000 4,680,000

4,000,000 336,000,000 4,680,000

4,000,000 336,000,000 4,680,000

1,215,320,000 0.909 1,104,836,364

240,320,000 0.826 198,611,570

344,680,000 0.751 258,963,186

344,680,000 0.683 235,421,078

344,680,000 0.621 214,019,162

<0, Therefore do not do the complete funding Years > 5 years, therefore do not do the complete funding

[(ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)COMPLETE FUNDING (ProbabilityNO ACCIDENT  CostNO ACCIDENT + ProbabilityMINOR  CostMINOR + ProbabilityMODERATE  CostMODERATE + ProbabilitySIGNIFICANT  CostSIGNIFICANT)NO FUNDING]  (1 0.40). *(Initial Investment  15)  0.40. **[((SP VC)  Units FC)COMPLETE FUNDING ((SP VC)  Units FC)NO FUNDING]  (1 Tax Rate).

G. Chevis, M. Stuebs / J. of Acc. Ed. 30 (2012) 307–324

150,000,000

Payback period 

1

Initial repairs and maint. investments Depreciation tax shield* Operating income** Estimated accident cost**

323

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