Santos Financial Analysis and Capital Budgeting

Santos Capital Budgeting and Financial Analysis

2a) Company Perspective

Working capital measures a company short-term financial health as well as a company's efficiency. To calculate a working capital ratio, the paper uses the following formula:

"Working Capital Ratio= Current Assets / Current Liabilities"

In other words, the working capital ratio measures a liquidity capability of a company that measures whether a company has enough working capital to settle its short-term liability. A working capital below one indicates a negative working capital revealing that a company will face challenges in settling its short-term liability. On the other a working capital of 1.2 and 2.0 reveals that a company has enough liquidity to settle its short liability. However, working capital above 2 shows that a company is not embarking on an investing policy.

The paper uses the following financial tools to measure the working capital efficiency of Santos Company:

Working Capital Ratio

Inventory Turnover Ratio

Santos Working Capital Efficiency ($Millions)

Working Capital Ratio

2014

2013

Total Current Assets

2065

2078

Total Current Liabilities

1946

Working Capital Ratio

2065/1946

2078/1726

Working Capital Ratio

1.06

1.20

The results of the Santos working capital efficiency reveals that the company has ability to settle its short-term liability in both 2013 and 2014 fiscal year. However, the results of the working capital ratio for 2013 fiscal year is more satisfactory than 2014 working capital ratio. The working capital ratio of 2013 fiscal year is 1.20, which is satisfactory compared to 2014 working capital ratio of 1.06 that is less satisfactory.

Inventory Turnover Ratio

Similarly, Santos inventory turnover ratio for the 2013 fiscal year is better than the inventory turnover ratio for the 2014 fiscal year.

Santos Working Capital Efficiency ($Millions)

Working Capital Ratio

2014

2013

Inventory Turnover Ratio

Sales

Cost of Sales

Inventory

Inventory Ratio

2889/443

2505/419

Inventory Ratio

6.52

5.97

The inventory turnover ratio reveals the number of Santos replaces and sells its inventory in a given period. The company inventory ratio is 6.52 in 2014 and 5.97 in 2013. As being revealed in the calculation below, Santos sells its entire inventory within 52.36 days in 2013 fiscal year compared to 55.98 days for 2014 fiscal year.

2014= (1 + 6.52) x 365 = 55.98 days.

2013 =(1 + 6.97) x 365 = 52.36 days.

The overall results reveals that Santos performs better in term of working capital efficiency in 2013 fiscal year than 2014 fiscal year.

2b)

In 2014, the Santos financing technique is through long-term debt. In the 2014 fiscal year, Santos issued a long-term debt of $1.57 Billion, and Santos issued its debt directly into the financial market to source for fund to finance its long-term investment. The company relies on direct borrowing to finance its large-scale project. In essence, Santos uses direct debt financing technique to predominantly finance its debt. Moreover, the company used $122 Million to finance its debts during 2014 fiscal year. The Australian dollar is the predominant currency that Santos used for borrowing. (Santos; 2014).

2c) The calculation starts in 2008 since the bond is purchased in 2008. The value of the yearly coupon of the bond is as follows:

2008= 0.040*1000= $40

2009= 0.040*1000= $40

2010= 0.040*1000= $40

2011= 0.040*1000= $40

2012= 0.040*1000= $40

2013= 0.040*1000= $40

2014= 0.040*1000= $40

2015= 0.050*1000= $50

The holding period returns for the Bond investment= $1,000+40+40+40+40+40+40+40+50= $1,330.

The holding period returns for the Bond investment= $1,330.

3. Capital Budgeting

3a) The paper uses the net income as free cash flow. However, the company free cash flow improves year after year as being revealed in the Excel workbook.

b) The paper calculates the NPV of the LNG Santos Project using the following costs of capital

a. A WACC of 5.94%

b. A WACC of 8%

It is not recommended for Santos to continuing investing in the project because the NPVs of the project costs of capital are negative NPV at both WACC revealing that Santos future cash flow is not enough to cover its cost of capital.

NPV of LNG Venture

WACC

5,94%

NPV

-$6,500.14

WACC

8%

NPV

-$9,027.98

c) The paper presents the IRR and Discounted Payback Period in the Excel workbook.

With Irregular Cash Flow

Result

The Investment will not pay back in 20 years. Average payback is $1,304.96 per year in the first 20 years. If it continues, the payback period will be 14,559,889.038 years.

With the discount rate of 5.40%, the Investment will not pay back in 20 years. An average discounted payback is $664.74 per year in the first 20 years. If it continues, the discounted payback period will be 28,582,526.416 years.

Return for the Cash Flow: -53.45% per year

Cash Flow

Net Cash Flow

Discounted Cash Flow

Net Discounted Cash Flow

Year 0

$-19,000,000,000.00

$-19,000,000,000.00

$-19,000,000,000.00

$-19,000,000,000.00

Year 1

$184.72

$-18,999,999,815.28

$175.26

$-18,999,999,824.74

Year 2

$304.76

$-18,999,999,510.52

$274.33

$-18,999,999,550.41

Year 3

$424.13

$-18,999,999,086.39

$362.22

$-18,999,999,188.19

Year 4

$542.91

$-18,999,998,543.48

$439.91

$-18,999,998,748.28

Year 5

$661.16

$-18,999,997,882.32

$508.28

$-18,999,998,240.00

Year 6

$778.98

$-18,999,997,103.34

$568.18

$-18,999,997,671.82

Year 7

$896.42

$-18,999,996,206.92

$620.34

$-18,999,997,051.48

Year 8

$1,013.58

$-18,999,995,193.34

$665.48

$-18,999,996,386.01

Year 9

$1,130.52

$-18,999,994,062.82

$704.23

$-18,999,995,681.78

Year 10

$1,247.31

$-18,999,992,815.51

$737.17

$-18,999,994,944.61

Year 11

$1,364.02

$-18,999,991,451.49

$764.85

$-18,999,994,179.76

Year 12

$1,480.73

$-18,999,989,970.76

$787.75

$-18,999,993,392.01

Year 13

$1,597.51

$-18,999,988,373.25

$806.34

$-18,999,992,585.68

Year 14

$1,714.43

$-18,999,986,658.82

$821.02

$-18,999,991,764.66

Year 15

$1,831.54

$-18,999,984,827.28

$832.16

$-18,999,990,932.50

Year 16

$1,948.93

$-18,999,982,878.35

$840.13

$-18,999,990,092.37

Year 17

$2,066.67

$-18,999,980,811.68

$845.24

$-18,999,989,247.13

Year 18

$2,184.80

$-18,999,978,626.88

$847.78

$-18,999,988,399.35

Year 19

$2,303.41

$-18,999,976,323.47

$848.01

$-18,999,987,551.35

Year 20

$2,422.57

$-18,999,973,900.90

$846.18

$-18,999,986,705.16

However, the IRR = 2% revealing the expected return on $19 Billion LNG investment after 20 years.

d. Sensitivity Analysis

The paper decreases growth rate in revenue by 5%, increases depreciation to $1.038 Billion and increases the cost of capital by 10% . By increasing the depreciation, the company records a decline in net revenue. Moreover, when the costs of capital increases by 10%, the NPV decline, and revenue growth rate declines. A disadvantage of sensitivity analysis is the assumption use to arrive at the value of the sensitivity may not happen in reality leaving management a confusion.

4. Investor Perspective

4a)

The paper uses the following formula to value the shares of Rio Tinto today:

Where k is a required rate of return

Where g is a constant growth rate

Where 2014 annual Dividends March is $77.98

Current Price = 77.98 (1+g 15%) / 15%-12%

Current Share Price Today = $2,911.25

I will purchase the shares because the company profitability ratio increases year after year. The gross margin increases yearly. The net margin also increases year after year as being revealed in the table below: