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Company Name: EOG Resources Inc. Individual Term Project Cost of Capital, Capital Structure, and Capital Budgeting Analysis Choose a publically traded company (Please get my approval for your...

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Company Name: EOG Resources Inc.

Individual Term Project

Cost of Capital, Capital Structure,

and Capital Budgeting Analysis

Choose a publically traded company (Please get my approval for your company so that two students cannot choose the same company) and analyze its financial ratios, capital structure, cost of capital and do a capital budgeting for your chosen company. (See below)

1. Purpose of the project:

In this project, you are supposed to be a financial manager working for a big corporation and you have to apply the knowledge obtained from the financial management (FIN6352) course to determine the cost of debt, cost of preferred stock, cost of common equity, capital structure, and the weighted average cost of capital (WACC) for a publicly-traded company of your choice. You will use the WACC as the discount rate to conduct capital budgeting analysis for a project that the firm is considering and then decide whether it should be accepted or not.

2. Outline for the project:

(1) Executive Summary (10 points)

- Summarize the results and analysis of the report.

(2) Financial Ratio Analysis (40 points)

You are supposed to be a financial analyst covering a firm in particular. You are expected to apply the knowledge obtained in the Financial Statement Analysis (ACC6351) course and determine the firm’s strengths and weaknesses relative to its peers and to describe historical growth of key variables.

- Perform trend analysis of the key financial ratios (i.e., liquidity ratios, asset management ratios, debt management ratios, profitability ratios, market value ratios) of the company.

- Perform industry (or benchmark companies) comparison analysis of the key financial ratios of the company.

- Based on the financial ratio analysis results, evaluate the financial performance of the company.

(3) Estimate Capital Structure (25 points)

- Estimate the firm’s weights of debt, preferred stock, and common stock using the firm’s balance sheet (book value).

- Estimate the firm’s weights of debt, preferred stock, and common stock using the market value of each capital component.

(4) Compute Weighted Average Cost of Capital (WACC) (35 points)

- Estimate the firm’s before-tax and after-tax component cost of debt; (Note: If the information about the current corporate tax rate is not available, you need to estimate the tax rate based on its historical tax payments).

- Estimate the firm’s component cost of preferred stock;

- Use three approaches (CAPM, DCF, bond-yield-plus-risk-premium) to estimate the component cost of common equity of the firm.

- Calculate the firm’s weighted average cost of capital (WACC) using market-based capital weights.

(5) Cash Flow Estimation (40 points)

- We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $195 million to purchase land, construct building, and purchase equipment, and $15 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of fixed assets is $38 million. The number of units of the new product expected to be sold in the first year is 880,000 and the expected annual growth rate is 9%. The sales price is $266 per unit and the variable cost is $179 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.8%. The required net operating working capital (NOWC) is 15% of sales. The company is in the 35% tax bracket. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Compute the depreciation basis and annual depreciation of the new project. (Please refer to table of 3 years MACRS allowances)

- Estimate annual cash flows for the 8 years.

- Draw a time line of the cash flows.

(6) Capital Budgeting Analysis (40 points)

- Using the WACC you obtained for the publicly-traded company as discount rate, apply capital budgeting analysis techniques (NPV, IRR, MIRR, PI, Payback, Discounted Payback) to analyze the new project.

- Perform a sensitivity analysis for the effects of key variables (e.g., sales growth rate, cost of capital, unit costs, fixed costs, sales price) on the estimated NPV or IRR in order to demonstrate the sensitivity of the model. The Scenario analysis of several variables simultaneously is encouraged, but not required.

- Discuss whether the project should be taken and summarize your report.

3. Other information regarding the project:

(1) Avoid firms in the financial sector. Their financial statements are not compatible with the type of model we study in this class. Generally, financial firms have 4-digit SIC codes 6000s.

(2) You will inform the instructor of the company you choose. Students have to choose different companies. If several students want to use the same company, the first student to inform the instructor will have priority; the others will have to pick another company.

(3) Your project should be well-organized and typed in a Word document and attach the necessary Excel worksheets with your report. The style and organization of the project account for 10 points.

Answered Same DayNov 15, 2019

Solution

David answered on Nov 30 2019
100 Votes
Company Name: EOG Resources Inc.
Individual Term Project
COST OF CAPITAL, CAPITAL STRUCTURE, AND CAPITAL BUDGETING ANALYSIS
(1) Executive Summary
The project undertakes the analysis of the capital components of the company EOG Resources INC. through ratio analysis, cost of capital and project evaluation.
The company is engaged in energy resources exploration, development and marketing especially natural gas. The ratio analysis of the company provides that the company’s position over the last two years is on declining trend and is demonstrating negative returns.
To evaluate further, using the book value and market value, weights of each capital component was calculated and thereby cost of capital was derived to be 11.35%.
This weighted average cost of capital is thus being applied to the project evaluation techniques and concluded with acceptance of the project.
Overall analysis provides that it’s better to hold the stock of the company considering the market scenario.
(2) Financial Ratio Analysis
Key Ratios:
Profitability-
    Profitability
    2007-12
    2008-12
    2009-12
    2010-12
    2011-12
    2012-12
    2013-12
    2014-12
    2015-12
    2016-12
    Tax Rate %
    33.17
    34.96
    37.31
    60.62
    42.87
    55.47
    36.07
    41.64
    —
    —
    Net Margin %
    26.82
    38.15
    11.42
    2.63
    10.78
    4.88
    15.17
    16.17
    -51.66
    -14.33
    Asset Turnover (Average)
    0.38
    0.46
    0.28
    0.30
    0.44
    0.45
    0.50
    0.55
    0.28
    0.27
    Return on Assets %
    10.08
    17.38
    3.21
    0.81
    4.70
    2.19
    7.59
    8.92
    -14.66
    -3.89
    Financial Leverage (Average)
    1.73
    1.77
    1.81
    2.11
    1.97
    2.06
    1.98
    1.96
    2.08
    2.11
    Return on Equity %
    17.29
    30.46
    5.75
    1.59
    9.54
    4.40
    15.31
    17.60
    -29.52
    -8.15
    Return on Invested Capital %
    15.64
    26.03
    5.46
    2.05
    7.86
    4.21
    11.89
    13.87
    -19.84
    -4.02
    Interest Coverage
    —
    —
    9.64
    4.15
    10.08
    7.00
    15.60
    25.80
    -28.16
    -4.53
· In terms of profitability, the company seems to have been struggling since last few years. The profitability of the company has been on a decreasing trend which can be seen from the declining percentage of Net Margin. From 26.82% in 2007 it has fallen down to negative 14.33% in 2016.
· Further, return of assets has decreased from 10.08% in 2007 to negative 3.89% in 2016. Although there is improvement with regard to the performance in year 2015 when the return of assets was negatively as high as 14.66%. The losses seem to have lowered down in 2016 but still the performance remains poor as compared to the last few years.
Liquidity/Financial Health
    Liquidity/Financial Health
    2007-12
    2008-12
    2009-12
    2010-12
    2011-12
    2012-12
    2013-12
    2014-12
    2015-12
    2016-12
    Cu
ent Ratio
    0.88
    1.19
    1.37
    1.14
    1.29
    1.23
    1.42
    1.60
    1.42
    1.75
    Quick Ratio
    0.68
    0.61
    1.11
    0.88
    0.83
    0.88
    1.04
    1.16
    0.93
    1.40
    Financial Leverage
    1.73
    1.77
    1.81
    2.11
    1.97
    2.06
    1.98
    1.96
    2.08
    2.11
    Debt/Equity
    0.17
    0.21
    0.28
    0.48
    0.40
    0.44
    0.38
    0.33
    0.51
    0.50
    
    
    
    
    
    
    
    
    
    
    
· The liquidity of the company is getting stronger each year. The cu
ent ratio of the company was as low as 0.88 in 2007 which has improved significantly in past few years and reached to 1.75 in 2016. This ratio measure is highest the company has had since 2007.
· Just like the cu
ent ratio, same trend has been observed in quick ratio as well. From 0.68 in 2007 the ratio risen to 1.40 in 2016. Having a quick ratio of 1.40 signifies very strong short term liquidity position of the company but a check has to be done that whether the company has idle cash resources lying with it.
· The company has shown greater reliance on debt funds in the past few years. The capital structure of the company constituted debt as low as 0.17 times of the equity of the company in 2007. But this ratio has now increased to 0.50 in 2016. Needless to say, although the increase in debt results in higher fixed financial cost commitments, but it also provides a cheaper source of funds.
Efficiency Ratios
    Efficiency
    2007-12
    2008-12
    2009-12
    2010-12
    2011-12
    2012-12
    2013-12
    2014-12
    2015-12
    2016-12
    Days Sales Outstanding
    71.84
    44.53
    56.96
    56.39
    46.22
    48.55
    41.77
    34.79
    56.47
    51.21
    Days Inventory
    43.02
    41.53
    71.92
    87.68
    109.46
    122.35
    98.78
    83.74
    110.95
    88.80
    Payables Period
    408.15
    325.36
    336.08
    342.17
    402.28
    395.03
    343.41
    337.33
    368.19
    279.24
    Cash Conversion Cycle
    -293.30
    -239.30
    -207.20
    -198.11
    -246.60
    -224.13
    -202.87
    -218.79
    -200.77
    -139.22
    Receivables Turnove
    5.08
    8.20
    6.41
    6.47
    7.90
    7.52
    8.74
    10.49
    6.46
    7.12
    Inventory Turnove
    8.49
    8.79
    5.08
    4.16
    3.33
    2.98
    3.70
    4.36
    3.29
    4.11
    Fixed Assets Turnove
    0.44
    0.53
    0.32
    0.35
    0.51
    0.52
    0.59
    0.65
    0.33
    0.31
    Asset Turnove
    0.38
    0.46
    0.28
    0.30
    0.44
    0.45
    0.50
    0.55
    0.28
    0.27
· The company has strong receivables turnover of 7.12 times which shows that the company is able to realize cash from its debtors without much delay. This ratio has been improving continuously over the years.
· Inventory turnover ratio has not shown performance as good as compared to the past years. From 8.49 in 2007 it has fallen down to 4.11 in 2016.
Financials – Industry Comparison
    
    Company
    Industry
    Price/Earnings (TTM)
    247.39
    -47.6
     Price/Book (MRQ)
    4.22
    1.42
    Price/Cash Flow (MRFY)
    22.02
    7.46
     Dividend Yield
    0.66%
    0.00%
     Net Profit Margin (TTM)
    0.10%
    0.61%
    Return on Equity (TTM)
    1.73%
    1.73%
    Debt to Equity (MRQ)
    0.46
    36.64
· The industry in which the company operates has a negative PE Ratio of 47.6 times whereas the company has a much more stronger PE ratio of 247.39 times.
· Having the same percentage of return on equity as compared to industry, the company really struggles in terms of profitability. The Net Profit Margin of the company is just 0.10% as compared to 0.61% in the industry.
Cu
ent Ratio – Industry and Competitors
    EOG Resources Inc., cu
ent ratio, comparison to Oil & Gas Producers secto
    
    
    
    
    
     
    EOG Resources Inc.
    Oil & Gas Producers
    
    
    Dec 31, 2005
    1.33
    1.38
    
    
    Dec 31, 2006
    1.08
    1.18
    
    
    Dec 31, 2007
    0.88
    1.25
    
    
    Dec 31, 2008
    1.19
    1.24
    
    
    Dec 31, 2009
    1.37
    1.14
    
    
    Dec 31, 2010
    1.14
    1.24
    
    
    Dec 31, 2011
    1.29
    1.15
    
    
    Dec 31, 2012
    1.23
    1.28
    
    
    Dec 31, 2013
    1.42
    1.14
    
    
    Dec 31, 2014
    1.60
    1.12
    
    
    Dec 31, 2015
    1.42
    1.04
    
    
    Dec 31, 2016
    1.75
    1.02
    
    
    Source: Based on data from EOG Resources Inc. Annual Reports
    
    
    
    
    
    
    
    Source: https:
www.stock-analysis-on.net
    
    
The company has been able to maintain a strong cu
ent ratio as compared to the cu
ent ratio of the industry.
    EOG Resources Inc., cu
ent ratio, comparison to competitors
    
    
    
    
    
    
    
    
    
     
    EOG Resources Inc.
    Anadarko Petroleum Corp.
    Chevron Corp.
    ConocoPhillips
    Exxon Mobil Corp.
    Occidental Petroleum Corp.
    Phillips 66
    Dec 31, 2005
    1.33
    1.21
    1.37
    0.92
    1.58
    1.54
    –
    Dec 31, 2006
    1.08
    0.28
    1.28
    0.95
    1.55
    1.27
    –
    Dec 31, 2007
    0.88
    0.86
    1.17
    0.92
    1.47
    1.37
    –
    Dec 31, 2008
    1.19
    0.97
    1.14
    0.96
    1.47
    1.17
    –
    Dec 31, 2009
    1.37
    1.59
    1.42
    0.89
    1.06
    1.33
    –
    Dec 31, 2010
    1.14
    1.62
    1.68
    1.26
    0.94
    1.67
    –
    Dec 31, 2011
    1.29
    1.41
    1.58
    1.08
    0.94
    1.45
    –
    Dec 31, 2012
    1.23
    1.70
    1.63
    1.38
    1.01
    1.30
    1.44
    Dec 31, 2013
    1.42
    1.25
    1.52
    1.26
    0.83
    1.34
    1.49
    Dec 31, 2014
    1.60
    1.10
    1.32
    1.31
    0.82
    1.68
    1.50
    Dec 31, 2015
    1.42
    0.95
    1.34
    0.95
    0.79
    1.37
    1.63
    Dec 31, 2016
    1.75
    1.58
    0.93
    1.25
    0.87
    1.32
    1.34
    Source: Based on data from EOG Resources Inc. Annual Reports
     
     
     
     
    
    
    
    
    
    
    
    
    Source: https:
www.stock-analysis-on.net
    
    
    
    
    
EOG Resources Inc. possess a strong liquidity position with a cu
ent ratio of 1.75 which is much higher as compared to its...
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