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Advanced Strategic Management

Abstract

The report has analysed the acquisition and possible outcome of the same in future. The report has presented the background of two companies – both the target and acquirer. The analysis is based on some underlying assumptions, which are associated with the performance of IGAS. Further, the report has analysed that investment is not financial feasible for Shell as the company would not recover its investment in the next ten years at present value of money.

Executive summary

The report has presented a feasibility test of acquisition of IGAS by Shell Inc. the report has evaluated the background of both of these companies at first stage. The background of these companies has revealed that IGAS has significant possibility to become a leader to provide natural gas from shale oil. However, the background does not provide any conclusion regarding financial feasibility to investment for this acquisition. So, this study has conducted a feasibility test on investment by adjusting cash flow for the next ten years of IGAS. The report has conducted the analysis on basis of secondary information present in annual report and presentation of IGAS to its investors. The stress test on financial as well as operational performance of IGAS has provided that net cash flow of the business would be positive for the company. However, the present value of the investment is negative at several discounting factors after sensitising the discounting factor at different rates.

Background

IGAS is British oil and gas exploring company that has operation in Great Britain mainly. The company is engaged in exploring oil mainly in Northern Sea – Scotland, North West, East midlands and Southern England. The company has average production capacity of 2500 barrel per day whereas it has reserve of 2.3 billion barrels of oil. The company is engaged in exploring shale gas and coal bed methane gas from different sites. The recent study of geological survey has proved that the UK has a reserve of shale gas in the country. IGAS has the license of 102 Tcf between Manchester and Liverpool and it can meet the requirement of

Britain’s annual demand of gas (which is 3Tcf). The operation of IGAS has generated local employability and tax revenue for the country. Further, it has acquired DART, which has 10% stake in coal bed methane gas in Assam, India. The company is currently exploring oil only and it looks forward to explore shale gas in the UK. The 10% stake in coal bed methane gas in Assam has contributed significant revenue on consolidated basis as Dart has the license to exploration of methane from the bed (Igasplc.com, 2017). The current oil production has witnessed 2570 barrels per day on an average basis whereas it has started its capital expenditure to explore shale gas from the country. Additionally, the specialisation of this company is to explore oil from onshore fields only. The company is listed in Alternative investment market of LSE.

Shell is the largest oil exploration company in the world. This American multinational company has operations in several countries. Further, it is engaged in oil marketing and distributing in several places like USA, UK (BP oil) and others. The exploring operation is divided into three categories mainly – oil, natural gas and shale gas. The shale gas operation is the newest operational product for the company in the USA (Shell.com, 2017). The company has expanded its business by acquiring precious assets like oil and gas fields both offshore and onshore categories in several countries. Further, it has a long list of acquisition of foreign and domestic companies to make itself the largest companies in the world. It is assumed that recent result of survey in the UK has provided the company a real opportunity to expand its operation in the UK by acquiring IGAS. It would allow Shell to enhance its shale gas reserve in the world as well as new opportunity to acquire business segment in coal bedded methane gas in India.

Data sources

This study has been conducted to understand the feasibility of acquiring IGAS by Shell. The information related to evaluate the financial feasibility of acquiring the target company is conducted on the financial information provided with annual report of IGAS mainly. Further, the study has conducted a background checking on two companies in a formal way. The official websites and some other authentic sites are observed to obtain real information to check the backgrounds of these two companies. The financial data on cost and volume of revenue of IGAS are presented in final presentation to the investors of the company. Thereby, the data collection method of this study is secondary method only where secondary information is gathered without the consent of the company (Baskerville, and Wood-Harper, 2016). However, it is justified to gather this secondary information regarding IGAS as all the information is available in public.

Methodology

The methodology of study is important as it can deliver the insights of the outcome to a researcher (Nuttin, 2014). In this context, the study has conducted secondary research for analysing the feasibility of acquisition. However, the study is based on some of the assumptions to conduct the feasibility test. The studied method has followed positivist method to study the cash flow and sensitivity analysis of future cash flow of IGAS. The method has selected to deduce the financial theories, which are available in the academic context (Hair and Lukas, 2014). In addition to this, this study has gathered operational data from the annual presentations of IGAS. The operational information has provided the current operating benefits of the business as well as predicting the future opportunity of business. There are three types of information on IGAS are collected to complete this study – financial, operational and natural assets of the business. It has provided an idea of future business of the company as well as the sustainability of the same for long time (Crowe, 2015). This report has evaluated the feasibility studies on acquiring IGAS by Shell by projecting cash flow of the target company. In this context, an acquisition of a business has to undergo a stress test for projecting future cash flow of the acquired company. It provides the acquirer an idea of possible success in long run as well as feasibility of acquisition (Giel and Issa, 2011). It is normal for any investor to conduct a feasibility test for checking the stress of investment of acquiring a new business before making the investment for long-term (Bodie, 2013). Such research provides the investors ideas on feasibility of financial fund flows. Thereby, it is justified to conduct such financial feasibility test before investing for a long-term project. Further, financial analysis does not imply any conclusion for a business as the financial evaluation is based on historical data of the companies. Therefore, conducting a background checking and future possibilities due to precious natural assets of a company can yield important evaluation for assessing the investment appraisal. Thereby, it is justified to check the demand of the business as well as possible reserve of oil and gas of IGAS to predict the future possibility of cash flow for the company (Bierman and Smidt, 2012). Further, change in the price of commodity can grow uncertainties in the business. So, it is justified to conduct the a demand and supply match for evaluating the sustainability of the business.

Data analysis & Explanation

In this context, the study has conducted two types of data analyses for testing the feasibility of acquisition and investment. The first method of analysis is to generate a cash flow of operation of IGAS based on current data. The cash flow test has assumed that current revenue as well as expenses is aligned with the same level in future. Further, it is assumed that the price of oil would not be lowered from current level during the next ten years. However, the study has analysed revenue of oil only for projecting cash flow of IGAS. Additionally, the study has conducted a sensitivity test on cash flow to predict the future success of IGAS. The sensitivity analysis is prepared on basis of some assumptions. The underlying assumptions in sensitivity analysis are as follows:

  1. Sales volume would go up by 2% in every year due to hike in demand of the oil.
  2. Price of oil would go up by 3% every annum.
  3. Indirect cost or operating cost of IGAS would rise by 3.5% annually (as inflation rate of the UK is 3.5% for the last twenty years).
  4. It is assumed that selling price of oil would rise by 5% annually.

The sensitivity analysis has shown the outcome due to different situations in the business (Carr et al. 2010). The change in price of oil commodity can change the selling price of oil in the UK. Further, this analysing method has conducted the test on how change in operating as well as cost of materials can change the cash flow of IGAS. The cash flow statement with sensitised of different particulars can show different possibilities in cash flow for future.

Thereby, the analysis method of future cash flow can show the feasibility test of acquiring IGAS by Shell is justified for this study. Further, this study has conducted an appraisal of investment by using the discounted cash flow method to evaluate the present value of investment after ten years. The sensitivity analysis of present value of money has been conducted by sensitising various discounting factors to find the feasibility of acquiring IGAS by Shell. The study of present value of money provides the feasibility result of investment for future (Hasani-Marzooni and Hosseini, 2011). It is justified to test the result with different discounting factors as cost of equity of an investment might change in future due to economic uncertainties. Additionally, testing internal rate of return might show the possible rate of interest to make the return equating to zero of the initial investment for acquiring IGAS (Levy, 2015).

Interpretation of results

The test on cash flow has shown that net cash flow of the business is negative in the first year of the business. Further, change in cash flow is aligned with the change in other parameters of the business of IGAS for the next ten years. However, it is considered that capital expenditure of the company would remain at $12.4 million for the next ten years. The measurement of cash flow for the last nine years of the investment has yielded almost net $2.19 million for Shell after ten years. The internal rate of return in measured at 0% as the acquisition would not follow any cost of equity due to loss in the business. The measurement of net present value of the investment at different rate of discounting factors has yielded negative return for the investors. Such result depicts that investor cannot have any positive return after ten years in current circumstances with prediction for the next ten years of oil price. Therefore, interpretation of the test shows that investment in IGAS would yield negative return unless the price of oil is increased in future.

Conclusion

The analysis has been conducted considering the revenue generated for IGAS by selling oil only. However, the research has not considered any revenue from shale gas for the next ten years as the current operation of the company has not provided such data on generating revenue from this segment. Further, it is also considered that price of oil would go up substantially so that IGAS can increase its revenue by 5% annually. However, it is considered that increase in demand of oil would not affect the sales price at same level as the indirect cost of the business would go rise aligning with the inflation rate in the economy. Further, the result has shown that investment in IGAS would return a negative result to the investors due to poor profit margin as well as slow growth in price of oil. Therefore, it can be concluded that acquiring IGAS is not worthy for Shell as the company cannot get the return of its investment within ten years of acquiring the business. However, it may be concluded that accumulating revenue from shale gas might enhance the overall revenue as well as cash flow of the business. It would help to generate more cash for the business in future. Thus, Shell can consider to invest in IGAS if the capital expenditure rate of the company remains at the same level in future.

Appendix 1 – Cash flow & sensitivity analysis

Financial Forecasts

Month

1

2

3

4

5

6

Sales Volume, Units

Product 1

( 1003750 1023825

1044302

1065188

1086491

1108221

Product 2

Total Sales Volume, Units

Operating Costs, $

References

Baskerville, R.L. and Wood-Harper, A.T., 2016. A critical perspective on action research as a method for information systems research. In Enacting Research Methods in Information Systems: Volume 2 (pp. 169-190). Springer International Publishing.

Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of investment projects. Routledge.

Bodie, Z., 2013. Investments. McGraw-Hill.

Carr, C., Kolehmainen, K. and Mitchell, F., 2010. Strategic investment decision making practices: A contextual approach. Management Accounting Research, 21(3), pp.167-184.

Crowe, C., 2015. Real estate investment analysis.

Giel, B.K. and Issa, R.R., 2011. Return on investment analysis of using building information modeling in construction. Journal of Computing in Civil Engineering, 27(5), pp.511-521.

Hair Jr, J.F. and Lukas, B., 2014. Marketing research. McGraw-Hill Education Australia.

Hasani-Marzooni, M. and Hosseini, S.H., 2011. Dynamic model for market-based capacity investment decision considering stochastic characteristic of wind power. Renewable Energy, 36(8), pp.2205-2219.

Igasplc.com. (2017). IGas | At a glance. [online] Available at:

https://www.igasplc.com/about-us/at-a-glance [Accessed 9 Apr. 2017].

Levy, H., 2015. Stochastic dominance: Investment decision making under uncertainty. Springer.

Mitchell, C., Theron, L., Stuart, J., Smith, A. and Campbell, Z., 2011. Drawings as research method. In Picturing research (pp. 19-36). SensePublishers.

Nuttin, J., 2014. Future time perspective and motivation: Theory and research method. Psychology Press.

Shell.com. (2017). Shell Global. [online] Available at: http://www.shell.com [Accessed 9

Apr. 2017].

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