cima report.docx

1、cima report1. IntroductionYJ Ltd (YJ) is a UK company which was listed on AIM in January 2007 with an initial public offering (IPO) of US$60 million，whose main shareholders are 12 large institutional shareholders. The main operational activities of YJ are the exploration of, and production from oil

2、and gas fields. The companys competitive and development strategy is to explore, appraise and develop into production its licensed oil and gas fields abidingly.However as YJ is planning to explore, appraise and develop into production its licensed oil and gas fields, there is potential risk and prob

3、lems of YJ companys plan of new production. Several problems and incidents of YJ need analysis in order to achieve its sustainable development and profit.2. Terms of ReferenceThe report is designed to prioritize, analyze and evaluate the issues facing the YJ company. Detailed recommendation is made

4、toward these problems.3. Identification and prioritization of issuesPriorityIssueFinancialW1FeasibilityW2UrgencyW3TotalPriority150.550.350.251220.550.330.23.14350.540.350.24.72430.530.320.22.85540.530.330.23.53IssueFinancialFeasibilityUrgency15 points: will influence the profitability and the risk o

5、f the company strongly.5 points: the solution is reasonable and feasible.5 points: should be decided before the license goes expire.22 points: the accounting method will influence the decision made in the future but not influence much.5 points: the exchange of accounting method is easy to realize. 3

6、 points: should be decided , but not so urgent.35 points: will influence the profitability and the risk of the company strongly.4 points: the acceptance of the farm-out offer requires several condition and require cash to commence the project.5 points: the proposal should be decided before August.43

7、 points: will influence the profitability in the future3 points: this proposal requires new method to exploit new resources, which is hard to realize.2 points: the oil field can still make profit for around 7 years.54 points: will influence the profitability and the risk of the company.3 points: req

8、uires a lot of cash, which needs to be raised.3 points: the decision neednt be made within 1 year.Priority 1Issue 1 Financial decision of the companyGiven that the company has won the test license of three oil field and the cash flow can not support the company to test all three of them, the company

9、 should decide whether to raise money to test all three oil field. If yes, which method should be taken, debt or equity should be used to raise money.Priority 2Issue 3 Farm-out offer of GGG provided by LGThe company has received an offer provided by LG. Given the company hasnt an enough cash flow to

10、 bring GGG into production, whether the company should receive the offer provided by GGG.Priority 3Issue 5 Accelerating operation of new oil and gas fieldsThe new CEO Uilan Shah wants YJ to identify and bring new oil and gas fields into operation at a faster rate than currently achieved, However, Or

11、it Mynde (CFO) thinks that most of current cash was spent on current operational oil and gas fields as well as on surveying potential new oil and gas fields, so there is not enough funding for testing and production new fields until YJ grant further licenses. Whether we should accelerating operation

12、 of new oil and gas fields remains a big question.Priority 4Issue 2 Accounting method for oil and gas exploration costsThe GAAP accounting concept is that the oil and gas exploration costs are assets that are to be charged against revenues in the Profit or Loss Statement as the assets. However, the

13、accounting method used by YJ to account for oil and gas exploration costs is to capitalize all costs of exploration that lead to the successful generation of oil and gas fields, the drilling and exploration costs associated with oil and gas fields that are unsuccessful and will not go into productio

14、n are written off in their entirety. Whether we should transfer to GAAP should be discussed.Priority 5Issue 4 The sustainability of energy sourcesYJs existing reserves from oil fields already in operation will last around seven more years. With specific regard to the inherent lack of sustainability

15、of fossil fuels, for YJs long-term future, it could simply exit the E&P market once its fields run dry or become an energy company where it sources energy in a broader sense from wherever is viable. 4. Analyses and evaluationSWOT analysis (Appendix 1), PEST analysis (Appendix 2), Porters five forces

16、 analysis ( Appendix 3 ),and other analyses are performed to lay a foundation for the analyses and get a better understanding of YJ company and the oil and gas industry.4.1 Financial decision of the companyJudging from appendix 6, we can assume at March, 31st 2015, the company has 70 million dollar

17、available. As theres 36.9 million trade payable and 13.4 million tax payable on that time point, let alone the secure demand for the company to hold a certain amount of money to keep company turnover, the maximum cash for the company to invest on the test drill is no more than 20 million without mon

18、ey raising. As is mentioned in scenario, the company has won the right to test drill on three different fields (EEE, FFF and GGG), and the cost of the three drills are 20, 25, 18 million, it is impossible for the company to start to test all three oil field, we can only leave the right to test go ex

19、pire. Raise MoneyNot Raise moneyReturn If the company decide to raise money to test all three oil field, the company can earn a higher profit if the oil field proved to be economic to take in to production. If the company decide not to raise money, the company can only test one oil field, the maximu

20、m profit the company can earn is lower than raise money to test oil field.Risk If it is proven that it is uneconomic to bring these three oil fields into production, the company will burden a huge interest cost or equity dilution, which means a disaster to the shareholders. As the company uses inter

21、nal cash flow to test oil field, even if these three oil fields can not bring economic profit, the lost of shareholders is not that high (compare to the lose by raising money).The technique company used to measure an oil field is quite accurate, that means it is highly possible that theres economic

22、chance behind the sea. Whats more, according to scenario, the earning to sell a proven oil field to other company is quite high ($11 million/mmbbl* 810 mmbbl = around $100m).Thus, compare to potential profit, the risk to burden a loss is acceptable. We recommend the company to raise money to test al

23、l three oil field.Here comes the second question, should the company use debt financing or equity financing? The comparison between these method are as follows.Debt financingEquity financingComparisonamount74.2 million($71.4m*3-$140m)#87.5 million(10m*$35/4)#These two method are all enough for the c

24、ompany to test all three oil field.Tax shieldYes. According to average discount rate at oil and gas company (15%)*,and corporate tax rate (24%) ,interest rate(11%) ,the value of tax shield is $54.4M*No Tax shield.According to MMII(with corporate tax), the value of the company rises because of the de

25、bt financing.RiskHigh, compare to equity financing, higher return while good situation ,vice versa.Low, compare to debt financing, lower return while good situation, vice versa.According to MMI, company with leverage suffers a higher risk.Bankrupt riskHighLowWhen the asset cannot cover liability, th

26、e company goes bankrupt. Higher debt means higher risk.Stock PriceStock price may goes upStock price may goes downAccording to an empirical analysis$, the stock price may be influenced by financing method. An seasoned issued equity means a 2% decrease in stock price.Notes:#: According to the scenari

27、o, company is allowed to lend a maximum of three times of operating profit.#: According to the scenario, one in four is generally works well in this industry.*: Sources: 2014 Property Value Study Discount Rate Rangefor Oil and Gas Properties*: $: sources, Shah K. The nature of information conveyed b

28、y pure capital structure changesJ. Journal of Financial Economics, 1994, 36(1): 89-126.Suitability:Equity method is more appropriate for the market as the leverage ratio at that time point is higher than the market average, a debt financing may cause a higher leverage ratio.Acceptability:As the comp

29、any still have three oil fields (AAA,BBB, and CCC), and the cash flow will last about 7 years. Even if the company cannot make it to make profit from EEE,FFF,GGG, the operating cash flow may remain about 7 years at a level of $71.4M per year. Given a discount rate of 15%(much higher than the interes

30、t rate bank charge), the present value of that cash flow is $297M, far overweigh than the debt. Thus, the bankrupt risk of the company is limited. Compare to the tax shield effect ($54.4M) and stock price effect (about 2%*10m*$35 = $7M), we recommend a debt financing method.Feasibility:As given in t

31、he chart, both methods are feasible.Judging from factors above, although the leverage ratio is higher than the average, the bankrupt risk is not higher enough to neutralize the value effect provided by the debt financing.4.2: Accounting method for oil and gas exploration costsGAAP is the standard fr

32、amework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards or standard accounting practice. Many countries use or are converging on the International Financial Reporting Standards (IFRS) that was established and is maintained by the International Accountin