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Answer the following questions with the aid of excel spreadsheets. You also need to answer the below questions in your word file and refer to your excel spreadsheets as supporting documents. Assume all figures are in USD.

Imagine that in 2016 Shell is evaluating whether to undertake a gas project in a country which is highly risky. The annual total incremental revenues for the gas project is $3,633,300,000. The total incremental costs project are 30% of the incremental revenues for this project. Assume that the incremental depreciation for the gas project is $889,200,000 per year. Assume that the free cash flows for the project will continue for 20 more years with the first cash flow occurring at the end of next year and that the initial investment in the project being made today. Assume that the initial outlay for this project is $27 billion USD. 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.

a) Based on the above information and sources what are the free cash flows to the Shell’s gas project? 
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.
a. A WACC (cost of capital) of 5.94%?
b. A WACC (cost of capital) of 8%?
 

Overview of Woodside Petroleum Limited

Woodside petroleum limited is an exploration and manufacturing company. This company is operating its business in Australian market. Woodside petroleum has the largest share in the gas and oil exploration industry of Australia. Head office of this company is situated is at Perth in Australia. This company has registered its stock in stock exchange of Australia. The main operations of this company are to exploration and deliver the oil and gas products in the Australian market. Various mines are owned by the company in Australia itself (Home, 2018).  This company has most of the natural gas projects in Australia. 13.5% share of oil and gas exploration industry is held by Woodside petroleum limited only. This market share is the highest in the Australian market.

Oil and gas exploration industry of Australia is one of the largest industries in ASX.  This industry contributes 2.58% in the total GDP of the country. The current reports and the future trends of oil and gas exploration industry of Australia explains that the company has faced few losses in last year due to natural and environment factor and future trend explains that the firms in oil and gas industry must run the business though concerning about natural aspects (Annual report, 2018).

The main key opportunity of Woodside petroleum limited is high technology of which would assist the organization to grab more market share. Through the help of technology, international project could also be owned by the company and the mission of the company could be accomplished. On the other hand, huge competition at international level is the main threat of the company and the bad relations of the company with its stakeholders would also impact over the performance of the company. Thus the company is required to manage the threats by identifying and taking a better step at fair time.

Cash conversion cycle (CCC) is a financial analysis process which is used by the companies, management and the professionals to evaluate the cash turnover of the company. It directly impacts over the liquidity and working capital management position of the company. Cash conversion cycle calculations express about the total time in which the cash of the company would be get back. Below table express about the cash conversion cycle of last 2 years:

Calculation of cash conversion cycle of 2016

Sales

 £      4,075

COGS

 £      2,234

Inventories

 £             5

AR

 £         172

AP

 £         546

Days/year

365

Cash conversion cycle (CCC)

=

Inventory conversion period

+

Receivables collection period

-

Payables deferral period

=

Inventory/Sales per day

+

AR/Sales per day

-

AP/COGS per day

=

                 0.45

+

                 15.41

-

48.91

=

               33.05 days

Calculation of cash conversion cycle of 2015

Sales

 £      5,030

COGS

 £      3,073

Inventories

 £           19

AR

 £           93

AP

 £         813

Days/year

365

Cash conversion cycle (CCC)

=

Inventory conversion period

+

Receivables collection period

-

Payables deferral period

=

Inventory/Sales per day

+

AR/Sales per day

-

AP/COGS per day

=

1.38

+

                6.75

-

            59.00

=

          - 50.87

(Arnold, 2013)

The above table of cash conversion cycle expresses about the total days which would be required by the company to get back the total investment cash for operations and daily activities. The CCC of 2015 was -50.87 days and in 2016, it was -33.05 days. This explains that the average receivable collection days have been enhanced in 2016. Though, the current CCC position of the company expresses that the current working capital position of the company is in negative. It expresses that the current asset of the company is quite lower than the current liabilities of the company. Though, the cash turnover of the company is quite higher and explains that the good position could be maintained by the company.

Oil and Gas Exploration Industry of Australia

In addition, financing options have been evaluated which had been opted by the company to raise its short term and long term funds. For short term financing, accounting payable is the most used source for the company. The current payables of the company are $ 546. On the other hand, for long term financing, interest bearing liability is the most used source for the company. The current interest bearing liability of the company is $ 4897. At the same time, total short term debt of the company is $ 963 and total long term liabilities of the company are $ 8128 (Brealey, Myers and Marcus, 2007).

It explains that the long term as well as short term, both financing sources have been used by the company to manage its performance and the position in the market. Further, it also explains that the debt financing sources have been used by the company to reduce the level of the cost of the company.

Bond valuation is a process in which the current value of bond is calculated and it is compared with the face value of the bond. This study is comprised to evaluate the position of the bond in the market (Nobes and Parker, 2008). Bond valuation study has been conducted over Woodside petroleum limited to evaluate the current bond position of the company.

Position of the company

Bond-1

Face value

 $                                     100.00

Coupon

2.25%

Maturity

11

Yield (Half yearly)

2.62%

Price of bond

Bond-1

Face value

                                             100

Coupon (half yearly)

1.13%

Maturity

11

Maturity (half yearly)

22

Yield (half yearly)

1.31%

Valuation of bond

                                          78.44

(Besley and Brigham, 2008)

The current value of the bond is $ 98 which is quite higher than the bond value of the company which is $ 78.44.

The study over current bond value explains that this change have occurred due to changes in the market. The YTM has impacted over the bond valuation. The current price of bond is below par due to various market factors and the bond position in the market.

Share valuation is a process in which the intrinsic value of share is calculated and it is compared with the market value of the bond (Marginson, 2009). This study is comprised to evaluate the position of the bond in the market. Share valuation study has been conducted over Woodside petroleum limited to evaluate the current share position of the company.

Required rate of return

Risk free rate

1.25%

Expected rate of return on market portfolio

9.00%

systematic risk of common stock

1.12

Required rate of return

9.93%

calculations:

r= R(f)+ beta{E(R(m)-R(f)}

Dividend Discount Model

Required rate of return

9.93%

Dividend amount

1.41

growth rate

5.00%

Intrinsic Value

 $           30.03

Intrinsic value in euro

 €           24.87

Share Price

 €           28.83

Undervalued

(yahoo Finance, 2018)

The above calculations express that the intrinsic value of the share is Euro 24.87 which is lower than the market price of the company, Euro 28.83. For calculating the share price of the company, dividend discount model has been used. As the current share price of the company is undervalued, so it would be the right time for the investors to buy the shares as in lower price the high worth shares could be bought by the investors now, it would offer great return to the investors in near future.

Free cash flows brief about the total cash inflow of a company (Phillips and Stawarski, 2016). Following is the free cash flow of investment opportunity of Shell:

Project A

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Year 11

Year 12

Year 13

Year 14

Year 15

Year 16

Year 17

Year 18

Year 19

Year 20

Initial Outlay

 $ 27,00,00,00,000

Revenues

 $ 3,63,33,00,000

 $ 3,70,59,66,000

 $ 3,78,00,85,320

 $ 3,85,56,87,026

 $ 3,93,28,00,767

 $  4,01,14,56,782

 $4,09,16,85,918

 $  4,17,35,19,636

 $ 4,25,69,90,029

 $ 4,34,21,29,830

 $ 4,42,89,72,426

 $  4,51,75,51,875

 $  4,60,79,02,912

 $  4,70,00,60,970

 $ 4,79,40,62,190

 $      4,88,99,43,434

 $     4,98,77,42,302

 $   5,08,74,97,148

 $ 5,18,92,47,091

 $  5,29,30,32,033

Expenses

 $ 1,08,99,90,000

 $ 1,11,17,89,800

 $ 1,10,00,04,828

 $ 1,12,20,04,925

 $ 1,14,44,45,023

 $  1,16,73,33,924

 $1,19,06,80,602

 $  1,21,44,94,214

 $ 1,23,87,84,098

 $ 1,26,35,59,780

 $ 1,28,88,30,976

 $  1,31,46,07,596

 $  1,34,08,99,747

 $  1,36,77,17,742

 $ 1,39,50,72,097

 $      1,42,29,73,539

 $     1,45,14,33,010

 $   1,48,04,61,670

 $ 1,51,00,70,904

 $  1,54,02,72,322

EBDT

 $ 2,54,33,10,000

 $ 2,59,41,76,200

 $ 2,68,00,80,492

 $ 2,73,36,82,102

 $ 2,78,83,55,744

 $  2,84,41,22,859

 $2,90,10,05,316

 $  2,95,90,25,422

 $ 3,01,82,05,931

 $ 3,07,85,70,049

 $ 3,14,01,41,450

 $  3,20,29,44,279

 $  3,26,70,03,165

 $  3,33,23,43,228

 $ 3,39,89,90,093

 $      3,46,69,69,894

 $     3,53,63,09,292

 $   3,60,70,35,478

 $ 3,67,91,76,188

 $  3,75,27,59,711

Less: Depreciation

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

 $   88,92,00,000

 $     88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

 $     88,92,00,000

 $     88,92,00,000

 $    88,92,00,000

 $         88,92,00,000

 $        88,92,00,000

 $      88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

EBT

 $ 1,65,41,10,000

 $ 1,70,49,76,200

 $ 1,79,08,80,492

 $ 1,84,44,82,102

 $ 1,89,91,55,744

 $  1,95,49,22,859

 $2,01,18,05,316

 $  2,06,98,25,422

 $ 2,12,90,05,931

 $ 2,18,93,70,049

 $ 2,25,09,41,450

 $  2,31,37,44,279

 $  2,37,78,03,165

 $  2,44,31,43,228

 $ 2,50,97,90,093

 $      2,57,77,69,894

 $     2,64,71,09,292

 $   2,71,78,35,478

 $ 2,78,99,76,188

 $  2,86,35,59,711

Less: Taxes

 $    49,62,33,000

 $    51,14,92,860

 $    53,72,64,148

 $    55,33,44,631

 $    56,97,46,723

 $     58,64,76,858

 $   60,35,41,595

 $     62,09,47,627

 $    63,87,01,779

 $    65,68,11,015

 $    67,52,82,435

 $     69,41,23,284

 $     71,33,40,949

 $     73,29,42,968

 $    75,29,37,028

 $         77,33,30,968

 $        79,41,32,788

 $      81,53,50,643

 $    83,69,92,856

 $     85,90,67,913

EAT

 $ 1,15,78,77,000

 $ 1,19,34,83,340

 $ 1,25,36,16,344

 $ 1,29,11,37,471

 $ 1,32,94,09,021

 $  1,36,84,46,001

 $1,40,82,63,721

 $  1,44,88,77,795

 $ 1,49,03,04,151

 $ 1,53,25,59,034

 $ 1,57,56,59,015

 $  1,61,96,20,995

 $  1,66,44,62,215

 $  1,71,02,00,260

 $ 1,75,68,53,065

 $      1,80,44,38,926

 $     1,85,29,76,505

 $   1,90,24,84,835

 $ 1,95,29,83,331

 $  2,00,44,91,798

ADD: Depreciation

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

 $   88,92,00,000

 $     88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

 $     88,92,00,000

 $     88,92,00,000

 $    88,92,00,000

 $         88,92,00,000

 $        88,92,00,000

 $      88,92,00,000

 $    88,92,00,000

 $     88,92,00,000

cash inflow

 $ 49,10,21,44,825

 $ 2,04,70,77,000

 $ 2,08,26,83,340

 $ 2,14,28,16,344

 $ 2,18,03,37,471

 $ 2,21,86,09,021

 $  2,25,76,46,001

 $2,29,74,63,721

 $  2,33,80,77,795

 $ 2,37,95,04,151

 $ 2,42,17,59,034

 $ 2,46,48,59,015

 $  2,50,88,20,995

 $  2,55,36,62,215

 $  2,59,94,00,260

 $ 2,64,60,53,065

 $      2,69,36,38,926

 $     2,74,21,76,505

 $   2,79,16,84,835

 $ 2,84,21,83,331

 $  2,89,36,91,798

Total cash flow

    22,10,21,44,825

The above calculations explain that the total free cash inflow of the project would be 22,10,21,44,825. It explains that the investment opportunity of the company is quite good.

Further, for analyzing the investment opportunity in a better way, NPV has been calculated. Following is the calculations of NPV:

Calculation of Net Present Value (5.94%)

Years

Cash Outflow

Cash Inflow

Factors

P.V. of Cash Inflow

P.V. of Cash Outflow

0

27,00,00,00,000

1

0

27000000000

1

1089990000

3633300000

0.94393053

3429582783

1028874835

2

1111789800

3705966000

0.89100484

3302033640

990610092

3

1100004828

3780085320

0.84104667

3179228160

925155394.6

4

1122004925

3855687026

0.79388962

3060989922

890748067.3

5

1144445023

3932800767

0.74937665

2947149066

857620378.2

6

1167333924

4011456782

0.7073595

2837542050

825724736.4

7

1190680602

4091685918

0.66769822

2732011413

795015321.1

8

1214494214

4173519636

0.63026073

2630405551

765448015.4

9

1238784098

4256990029

0.59492235

2532578499

736980343.3

10

1263559780

4342129830

0.56156536

2438389720

709571408.5

11

1288830976

4428972426

0.53007869

2347703903

683181835.6

12

1314607596

4517551875

0.50035746

2260390769

657773713.8

13

1340899747

4607902912

0.47230268

2176324886

633310541.8

14

1367717742

4700060970

0.44582092

2095385486

609757176.4

15

1395072097

4794062190

0.42082397

2017456292

587079780.9

16

1422973539

4889943434

0.39722859

1942425352

565245777.4

17

1451433010

4987742302

0.3749562

1870184877

544223799.3

18

1480461670

5087497148

0.3539326

1800631088

523983646.6

19

1510070904

5189247091

0.33408778

1733664064

504496242.7

20

1540272322

5293032033

0.31535566

1669187602

485733592.2

49003265123

41320534698

Net Present value = Present value of cash inflow- present value of cash outflow

 $     7,68,27,30,424

Calculation of Net Present Value (8%)

Years

Cash Outflow

Cash Inflow

Factors

P.V. of Cash Inflow

P.V. of Cash Outflow

0

27000000000

1

0

27000000000

1

1089990000

3633300000

0.92592593

3364166667

1009250000

2

1111789800

3705966000

0.85733882

3177268519

953180555.6

3

1100004828

3780085320

0.79383224

3000753601

873219297.8

4

1122004925

3855687026

0.73502985

2834045067

824707114.6

5

1144445023

3932800767

0.6805832

2676598119

778890052.7

6

1167333924

4011456782

0.63016963

2527898224

735618383.1

7

1190680602

4091685918

0.5834904

2387459434

694750695.2

8

1214494214

4173519636

0.54026888

2254822798

656153434.3

9

1238784098

4256990029

0.50024897

2129554865

619700465.7

10

1263559780

4342129830

0.46319349

2011246261

585272662.1

11

1288830976

4428972426

0.42888286

1899510358

552757514.2

12

1314607596

4517551875

0.39711376

1793982005

522048763.4

13

1340899747

4607902912

0.36769792

1694316338

493046054.3

14

1367717742

4700060970

0.34046104

1600187652

465654606.9

15

1395072097

4794062190

0.3152417

1511288338

439784906.5

16

1422973539

4889943434

0.29189047

1427327875

415352411.7

17

1451433010

4987742302

0.27026895

1348031882

392277277.7

18

1480461670

5087497148

0.25024903

1273141222

370484095.6

19

1510070904

5189247091

0.23171206

1202411154

349901645.8

20

1540272322

5293032033

0.21454821

1135610534

330462665.5

41249620914

39062512603

Net Present value = Present value of cash inflow- present value of cash outflow

 $ 2,18,71,08,312

The above calculations express that the investment opportunity of shell is way better because it would offer huge profits to the company in 5.49% as well as 8%. It explains that if the company would invest into this opportunity than  $7,68,27,30,424 would be the total profit of the company in case of 5.94% and  $2,18,71,08,312 would be the total profit in case of 8% (Moles, Parrino and Kidwekk, 2011). It explains that the both opportunities are good for the company. And company is recommended to invest into this company.

References:

Annual Report. Woodside petroleum limited. Available at https://www.woodside.com.au/Investors-Media/announcements/Documents/01.03.2017%20Annual%20Report%202016.pdf [Accessed on 12th Jan 2018].

Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.

Besley, S. and Brigham, E.F., 2008. Essentials of managerial finance. Thomson South-Western.

Brealey, R., Myers, S.C. and Marcus, A.J., 2007. FundamentalsofCorporate Finance. Mc Graw Hill, New York.

Home. 2018. Woodside petroleum limited. Available at https://www.woodside.com.au/Pages/home.aspx [Accessed on 12th Jan 2018].

Marginson, D.E., 2009. Beyond the budgetary control system: towards a two-tiered process of management control. Management Accounting Research, 10(3), pp.203-230.

Moles, P. Parrino, R and Kidwekk, D,.2011. Corporate finance, European edition, John Wiley &sons, United Kingdom

Nobes, C. and Parker, R.H., 2008. Comparative international accounting. Pearson Education.

Phillips, P.P. and Stawarski, C.A. 2016. Data Collection: Planning for and Collecting All Types of Data. John Wiley & Sons.

Yahoo Finance. 2018. Royal Dutch Shell plc. Available at https://au.finance.yahoo.com/quote/RDSA.AS?p=RDSA.AS [Accessed on 12th Jan 2018].

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