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Incremental revenues will increase by 2% per year and all costs will decrease by 3% per year starting at the end of year 2 for the life of the project. Assume depreciation remains constant over 20 years. All values are in USD. Assume the tax rate is 30% over the 20 years.

  1. a) Based on the above information and sources what are the free cash flows to the Shell’s gas project? (15 marks)
  2. b) Calculate the NPV for project using the below costs of capital and recommend whether at these two rates Shell should invest in the project.
  3. A WACC (cost of capital) of 5.94%?
  4. A WACC (cost of capital) of 8%? 

Background of the company

Woodside petroleum limited is the gas and oil company from Australia with the global recognition and presence for the exceptional capabilities as the developer, supplier, producer and explorer. It is the largest publicly traded gas and oil exploration company in Australia. The company has their main office in Perth, Australia. However, they have various other offices all over Australia. Global exploration portfolio of the company includes the interests over Myanmar, Senegal, Gabon, Morocco, New Zealand, Peru, Ireland and Australia. Its diverse portfolio represents the exploration strategy of the company all over the world. The company is engaged in production, marketing, development, evaluation and exploration of hydrocarbon. They operate in three segments these are producing that comprises the North West Shelf, natural gas that is Pluto liquefied and the Australia oil. Other segments of the company are inclusive of shipping and trading activities and are undertaken by Canada, Senegal, United States and other international areas. Further, the products of the company include pipeline gas, LNG, crude oil, liquefied petroleum gas and condensate (Woodside.com.au 2017).

The mission of the company is to deliver superior returns to the shareholders and their vision is to become the global leader in the upstream gas and oil. The main strategies of the company for achieving the vision are to to maximise the core asset’s value, growing the portfolio and leveraging the capabilities.

One key opportunity of the company is development of the projects for expanding the LNG capabilities of the company significantly that will assist in consolidating the position of Woodside as the global leader for LNG. However, the key threats to the company are that Australia is going through various natural disasters that include bushfires, earthquakes, landslides, cyclones, floods and severe storms. Another key threat is that the company is exposed to operating risks related to production and exploration activities.

It is the measurement that is used to analyse the efficiency of the management with regard to the overall health of the company. It measures how efficiently the company can transform its cash into accounts payable and inventory (Yazdanfar and Öhman 2014).

Cash conversion cycle

Ratio

Formula

2016

2015

Days inventory outstanding

Inventory/cost of sales

0.067

0.055

Days sales outstanding

Account receivable/net credit sales

0.109

0.097

Days payable outstanding

Accounts payable/cost of sales

0.244

0.265

Cash conversion cycle

-24.92

-40.89

It can be recognized from the above table that the cash conversion cycle of Woodside for the year 2015 was -40.89 whereas, the same for the year 2016 is -24.92. Unlike the negative cash flow, negative cash conversion cycle is good and states that the account receivable and account payables of the company are efficient. However, the cash conversion cycle of the company was better in 2015 as compared to 2016.

It measures the profitability of the company with regard to the capital used by the company.

Ratio

Formula

Woodside

Apache Corporation

BHP Billiton

Return on capital employed

Earnings before interest and tax/(total assets- current liabilities)

0.058

-0.081

-0.068

It can  identified from the above table that as compared to the competitors like BHP Billiton and Apache Corporation, the return on capital employed of Woodside is significantly better. Moreover, the competitors could not even generate positive return before interest and tax.

Long term debt refers to the financial obligation that is extended beyond the period of 12 months or beyond the operating cycle of the business (Diamond and He 2014). For example, pension benefits, bonds and convertible bonds. On the other hand, short term debt refers to the financial obligation due within the period of 12 months (Kahl, Shivdasani and Wang 2015). For example, accounts payable, income taxes payable, wages and short term loans from banks. During the year 2016 the company had long term interest bearing liabilities that includes debt facilities, bonds and medium term notes amounting to US $ 4,897 million and short term debt including payables amounting to US $ 546 million and interest bearing liabilities amounted to US $ 76 million.

Year

Initial investment

Incremental revenue

Incremental cost

Depreciation

NPBT

Tax @ 30%

NPAT

Depreciation

FCC

0

 $  -270000,00,000.00

 $ -270000,00,000.00

1

 $ 36333,00,000.00

 $ 10899,90,000.00

 $       8892,00,000.00

 $     16541,10,000.00

 $ 4962,33,000.00

 $ 11578,77,000.00

 $ 8892,00,000.00

 $     20470,77,000.00

2

 $ 37059,66,000.00

 $ 10784,36,106.00

 $       8892,00,000.00

 $     17383,29,894.00

 $ 5214,98,968.20

 $ 12168,30,925.80

 $ 8892,00,000.00

 $     21060,30,925.80

3

 $ 37800,85,320.00

 $ 11000,04,828.12

 $       8892,00,000.00

 $     17908,80,491.88

 $ 5372,64,147.56

 $ 12536,16,344.32

 $ 8892,00,000.00

 $     21428,16,344.32

4

 $ 38556,87,026.40

 $ 11220,04,924.68

 $       8892,00,000.00

 $     18444,82,101.72

 $ 5533,44,630.52

 $ 12911,37,471.20

 $ 8892,00,000.00

 $     21803,37,471.20

5

 $ 39328,00,766.93

 $ 11444,45,023.18

 $       8892,00,000.00

 $     18991,55,743.75

 $ 5697,46,723.13

 $ 13294,09,020.63

 $ 8892,00,000.00

 $     22186,09,020.63

6

 $ 40114,56,782.27

 $ 11673,33,923.64

 $       8892,00,000.00

 $     19549,22,858.63

 $ 5864,76,857.59

 $ 13684,46,001.04

 $ 8892,00,000.00

 $     22576,46,001.04

7

 $ 40916,85,917.91

 $ 11906,80,602.11

 $       8892,00,000.00

 $     20118,05,315.80

 $ 6035,41,594.74

 $ 14082,63,721.06

 $ 8892,00,000.00

 $     22974,63,721.06

8

 $ 41735,19,636.27

 $ 12144,94,214.15

 $       8892,00,000.00

 $     20698,25,422.12

 $ 6209,47,626.63

 $ 14488,77,795.48

 $ 8892,00,000.00

 $     23380,77,795.48

9

 $ 42569,90,029.00

 $ 12387,84,098.44

 $       8892,00,000.00

 $     21290,05,930.56

 $ 6387,01,779.17

 $ 14903,04,151.39

 $ 8892,00,000.00

 $     23795,04,151.39

10

 $ 43421,29,829.58

 $ 12635,59,780.41

 $       8892,00,000.00

 $     21893,70,049.17

 $ 6568,11,014.75

 $ 15325,59,034.42

 $ 8892,00,000.00

 $     24217,59,034.42

11

 $ 44289,72,426.17

 $ 12888,30,976.01

 $       8892,00,000.00

 $     22509,41,450.15

 $ 6752,82,435.05

 $ 15756,59,015.11

 $ 8892,00,000.00

 $     24648,59,015.11

12

 $ 45175,51,874.69

 $ 13146,07,595.53

 $       8892,00,000.00

 $     23137,44,279.16

 $ 6941,23,283.75

 $ 16196,20,995.41

 $ 8892,00,000.00

 $     25088,20,995.41

13

 $ 46079,02,912.18

 $ 13408,99,747.45

 $       8892,00,000.00

 $     23778,03,164.74

 $ 7133,40,949.42

 $ 16644,62,215.32

 $ 8892,00,000.00

 $     25536,62,215.32

14

 $ 47000,60,970.43

 $ 13677,17,742.39

 $       8892,00,000.00

 $     24431,43,228.03

 $ 7329,42,968.41

 $ 17102,00,259.62

 $ 8892,00,000.00

 $     25994,00,259.62

15

 $ 47940,62,189.84

 $ 13950,72,097.24

 $       8892,00,000.00

 $     25097,90,092.59

 $ 7529,37,027.78

 $ 17568,53,064.82

 $ 8892,00,000.00

 $     26460,53,064.82

16

 $ 48899,43,433.63

 $ 14229,73,539.19

 $       8892,00,000.00

 $     25777,69,894.45

 $ 7733,30,968.33

 $ 18044,38,926.11

 $ 8892,00,000.00

 $     26936,38,926.11

17

 $ 49877,42,302.31

 $ 14514,33,009.97

 $       8892,00,000.00

 $     26471,09,292.33

 $ 7941,32,787.70

 $ 18529,76,504.63

 $ 8892,00,000.00

 $     27421,76,504.63

18

 $ 50874,97,148.35

 $ 14804,61,670.17

 $       8892,00,000.00

 $     27178,35,478.18

 $ 8153,50,643.45

 $ 19024,84,834.73

 $ 8892,00,000.00

 $     27916,84,834.73

19

 $ 51892,47,091.32

 $ 15100,70,903.57

 $       8892,00,000.00

 $     27899,76,187.75

 $ 8369,92,856.32

 $ 19529,83,331.42

 $ 8892,00,000.00

 $     28421,83,331.42

20

 $ 52930,32,033.15

 $ 15402,72,321.65

 $       8892,00,000.00

 $     28635,59,711.50

 $ 8590,67,913.45

 $ 20044,91,798.05

 $ 8892,00,000.00

 $     28936,91,798.05

Total

 $     22125,492,411.00

Year

Cash flow

Discounting factor

Discounted cash flow

5.94%

8%

At 5.94%

At 8%

0

 $  -270000,00,000.00

1

1

 $  -270000,00,000.00

 $  -270000,00,000.00

1

 $     20470,77,000.00

0.9439

0.9259

 $     19322,98,470.83

 $     18953,88,594.30

2

 $     21060,30,925.80

0.8910

0.8573

 $     18764,83,746.52

 $     18055,00,312.69

3

 $     21428,16,344.32

0.8410

0.7938

 $     18022,08,544.87

 $     17009,67,614.12

4

 $     21803,37,471.20

0.7939

0.735

 $     17309,47,294.30

 $     16025,48,041.33

5

 $     22186,09,020.63

0.7494

0.6806

 $     16625,73,796.74

 $     15099,85,299.44

6

 $     22576,46,001.04

0.7074

0.6302

 $     15969,67,338.47

 $     14227,68,509.85

7

 $     22974,63,721.06

0.6677

0.5835

 $     15340,12,441.81

 $     13405,70,081.24

8

 $     23380,77,795.48

0.6303

0.5403

 $     14735,98,628.55

 $     12632,63,432.90

9

 $     23795,04,151.39

0.5949

0.5002

 $     14156,20,194.50

 $     11902,27,976.53

10

 $     24217,59,034.42

0.5616

0.4632

 $     13599,75,994.61

 $     11217,58,784.74

11

 $     24648,59,015.11

0.5301

0.4289

 $     13065,69,238.22

 $     10571,78,031.58

12

 $     25088,20,995.41

0.5004

0.3871

 $     12553,07,293.90

 $       9711,64,607.32

13

 $     25536,62,215.32

0.4723

0.3677

 $     12061,01,503.37

 $       9389,81,596.57

14

 $     25994,00,259.62

0.4458

0.3405

 $     11588,67,004.14

 $       8850,95,788.40

15

 $     26460,53,064.82

0.4208

0.3152

 $     11135,22,560.39

 $       8340,35,926.03

16

 $     26936,38,926.11

0.3972

0.2919

 $     10699,90,401.68

 $       7862,73,202.53

17

 $     27421,76,504.63

0.3750

0.2703

 $     10281,96,069.21

 $       7412,10,309.20

18

 $     27916,84,834.73

0.3539

0.2502

 $       9880,68,269.12

 $       6984,79,545.65

19

 $     28421,83,331.42

0.3341

0.2317

 $       9495,38,732.58

 $       6585,33,877.89

20

 $     28936,91,798.05

0.3154

0.2145

 $       9125,42,082.39

 $       6206,96,890.68

Total NPV

 $       3733,89,606.20

 $    -39553,71,577.00

It is identified from the above calculation that at 8% of cost of capital the project cannot earn a positive net present value and the NPV amounted to - $ 39553,71,577.00 whereas at 5.94% of cost of capital the project earned a positive net present value amounted to $ 3733,89,606.20. Therefore, shell shall invest only at 5.94%

Reference 

Diamond, D.W. and He, Z., 2014. A theory of debt maturity: the long and short of debt overhang. The Journal of Finance, 69(2), pp.719-762.

Kahl, M., Shivdasani, A. and Wang, Y., 2015. Short?Term Debt as Bridge Financing: Evidence from the Commercial Paper Market. The Journal of Finance, 70(1), pp.211-255.

Woodside.com.au., 2017. Strategy | About Us | Woodside Energy. [online] Available at: https://www.woodside.com.au/About-Us/Pages/Strategy.aspx#.WkcMddKWbIU [Accessed 30 Dec. 2017].

Yazdanfar, D. and Öhman, P., 2014. The impact of cash conversion cycle on firm profitability: an empirical study based on Swedish data. International Journal of Managerial Finance, 10(4), pp.442-452.

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