Chevron Corporation

Business Analysis and Equity Valuation

Valuated as of November 1st, 2007

Michael Eikenberry
Michael.Eikenberry@ttu.edu
Jonathan Lord
Jonathan.Lord@ttu.edu
Kelly Campbell
Kelly.Campbell@ttu.edu
Diana Duran
Diana.Duran@ttu.edu

1
 Table of Contents

Executive Summary 4
Business & Industry Analysis 8
Company Overview 8
Industry Overview 10
Five Forces Model 11
Rivalry Among Exiting Firms 11
Threat of New Entrants 17
Threat of Substitute Products 18
Bargaining Power of Buyers 21
Bargaining Power of Suppliers 23
Value Creation of the Industry 25
Value Creation of the Firm 28
Accounting Analysis 31
Key Accounting Policies 31
Potential Accounting Flexibility 34
Actual Accounting Strategy 36
Qualitative Analysis of Disclosure 38
Quantitative Analysis of Disclosure 40
Sales Manipulation Diagnostics 40
Expense Manipulation Diagnostic 45
Potential “Red Flags” 50
Accounting Distortions 51
Financial Analysis, Forecasts, and Cost of Capital Estimation 52
Financial Analysis 52
Liquidity Analysis 52
Profitability Analysis 60
Capital Structure Analysis 67

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IGR/SGR Analysis 71
Financial Statement Forecasting 73
Analysis of Valuations 82
Method of Comparables 82
Cost of Equity 87
Cost of Debt 88
Weighted Average Cost of Capital 88
Intrinsic Valuations 89
Discount Dividends Model 89
Free Cash Flows Model 91
Residual Income Model 93
Abnormal Earnings Growth Model 94
Long Run Residual Income Model 96
Credit Analysis 99
Analyst Recommendation 100
Appendix 101
Trend Analysis 101
Cost of Debt 103
Cost of Equity 104
WACC 104
Discount Dividends Model 121
Residual Income Model 122
Free Cash Flows Model 123
Abnormal Earnings Growth Model 124
Long Run Residual Income 125
Altman Z-score 126
References 127

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 Executive Summary

Investment Recommendation: Overvalued, Sell (11/1/07)

CVX - NYSE (11/1/07) $89.04 Altman-Z
52 Week Range $64.99-$95.50 2002 2003 2004 2005 2006
Revenue (2006) $210,118 B 2.52 3.16 3.87 3.55 3.85
Market
Capitalization $186.25 B
Shares Outstanding 2.11 B Valuation Estimates
Dividend Yield 2.60% Actual Price (11/1/07) $89.04
Percent Institutional Ownership 63.17% Trailing P/E $98.85
Book Value Per Share $35.49 Forward P/E $83.25
ROE 24.30% P.E.G. $93.20
ROA 12.90% P/B $96.39
P/EBITDA $79.69
Cost of Capital Est R2 Beta Ke EV/EBITDA $85.60
Ke Estimated
3-Month 0.1766 1.0557 13.07%
1-Year 0.1765 1.0541 13.06% Intrinsic Valuations
2-Year 0.1759 1.0516 13.25% Discounted Dividends $30.34
5-Year 0.1758 0.6707 9.96% Free Cash Flows $61.77
7-Year 0.1763 0.6713 10.01% Residual Income $68.59
10-Year 0.1764 0.6717 10.08% LR ROE $50.04
Published Beta 0.84 Abnormal Earnings Growth $49.59
Kd 5.91%
WACC BT 11.25%
WACC AT 10.72%

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 Industry and Company Overview
The Chevron Corporation is one of the world’s largest oil and gas
companies. It is headquartered in San Ramon, California and can trace its roots
back 125 years (chevron.com). Chevron is a leader both the upstream and
downstream aspects of the industry, thus controlling each step along the way.
Chevron is known for its broad span of gas stations around the world, but is also
involved other refined products, lubricants, and oil byproducts (chevron.com)
Chevron’s main competitors include ExxonMobil, ConocoPhillips, BP, and
Royal Dutch Shell. These companies are some of the largest and most powerful
corporations in the world. The world has a dependency on oil and gasoline, so
Chevron must make as much product available to consumers at the lowest price.
In an industry where the product is relatively the same, companies must focus
on cost leadership to maximize profits. This is part of why Chevron is a fully
integrated firm involved in each aspect of the process. Chevron owns the rigs
that drill for oil, the refineries that process it, the tankers that ship it, and the
stations that distribute it. There are some aspects of product differentiation that
Chevron uses to a point in order to increase sales. These include fuel additives
such as Techron, placing the product in the right places, and offering incentives
such as credit cards with discounts. Brand image also plays small role, but most
consumers realize there are no switching costs to buy someone else’s fuel. By
decreasing costs, Chevron can use those profits to buy more assets. This is the
name of the game in the oil and gas industry. Whoever can attain the most
assets will bring in the most sales. Chevron still has room to grow compared to
a couple of firms in the industry, but it seems to be moving in the right direction.

Accounting Analysis
Chevron’s 10-K is the basis for finding any information on their financial
statements and each aspect that goes into them. They also expound upon each
line item and point out any discrepancies or changes in accounting policy. A

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highly disclosed financial statement is pivotal in assessing a company’s
accounting strategies and potential problems. Comparing Chevron to the other
main competitors in the industry showed us Chevron has a high quality of
disclosure. Using our analysis of the industry, we were able to highlight
Chevron’s key success factors that must be assessed in the financial statements.
This also helped to point out any red flags that show Chevron taking advantage
of the flexibility of accounting. A main example of this is their slight adjustment
to goodwill which can overly inflate assets on the balance sheet. An extra $4
billion can have a significant impact especially as Chevron continues to acquire
firms. Amortizing goodwill over a short time period provides a better picture of
the firm. Overall, Chevron is fairly conservative in their accounting and are very
helpful in disclosing information valuable to anyone valuing the firm.

Financial Ratio Analysis

The financial statements are a machine that has many working parts that
all must work together to show the value of the firm. This can be assessed by
calculating different line items into ratios to be compared over time and against
other firms in the industry. The three main groups of ratios are liquidity,
profitability, and capital structure. We use liquidity ratios to value a firm’s ability
to meet its current debt obligations with liquid assets. Profitability ratios
measure the success the firm has at generating a profit through different inputs.
Lastly, the capital structure ratios determine the sources of financing used to
acquire assets. Altogether, they provide a snapshot of the firm and how its line
items relate to one another to perform financial activities.

Intrinsic Valuations
The most dynamic method of valuing the firm was through models such
as the discounted dividends, discounted free cash flows, residual income,

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abnormal earnings growth, and the long run residual income perpetuity. These
models used financial theory to assess the value of the firm using different
inputs. After finishing each model, we came to the conclusion that Chevron’s
stock as of November 1st, 2007 is overvalued. Averaging each calculated price
for each model gave us a price of $52.07 as opposed to the observed price of
$89.04. We feel that the true value of Chevron’s stock price is between $40 and
$60. We can say this with confidence because the valuation models each came
out close to these prices and the models with the highest explanatory value
came out at $50 per share. We also did an Altman-Z Score model to assess the
risk of bankruptcy and it came out at 3.84 which implies a low probability of any
financial trouble.

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 Business & Industry Analysis

Company Overview

Chevron is one of the top oil producing companies in the world. It was
first established by the Pacific Coast Oil Co, and has been around for more than
125 years (chevron.com). This was the first of many partnerships that created
today's global enterprise, spanning 180 countries (www.chevron.com). With an
economy that is reliant on a major energy source such as oil, Chevron becomes
one of the most significant companies in the world.
Chevron is a top producer of refined products, including gasoline,
lubricants, and aviation and marine fuels, in North America (chevron.com).
Texaco and Caltex are brand names under the Chevron Corporation, but they still
offer the same products and services that Chevron produces. Texaco’s products
and services are sold mainly in the U.S., Europe, South America, and West
Africa, while Caltex’s products and services are sold in Asia, Australia and parts
of the Middle East.
Keeping track of Chevron’s future ideas is imperative to figuring out what
the company will do without the essential fossil fuels. Looking at some of the
Research and Development plans will be a vital insight to whether this company
can survive the loss of their main product, oil. As stated on Chevron’s website,
“Chevron is among the largest publicly traded integrated energy companies in
the world in net proved crude oil and natural gas reserves, with a total 11.6
billion barrels-of-oil-equivalent (www.chevron.com).” Chevron has other projects
on their agenda not just being one of the top oil producers. They specialize in
exploration, production, and marketing, while refining oil mainly in the U.S. and
Asia. Chevron is also pursuing renewable fuels, including the creation of the
company’s new biofuels. This is all very important in Chevron’s pursuit of cutting

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edge research and development. If they can figure out a reliable alternative
fuel, or even a way to become fuel independent, then Chevron will forever be
notorious in the energy industry.
This report will consist of everything needed to know about Chevron as a
business and its addition to the communities. We will of course cover Chevron’s
accounting aspects and what they are researching, but more importantly what
they do to separate themselves as a company. You do not become the sixth
largest oil producing industry in the oil business by producing gas at a good price
alone. There are too many homogenous companies out there, so to exceed the
rest you need a solid image with a good marketing scheme.
Chevron’s stock has been on the rise lately going up $6.48 within the past
month. Overall since 2006 the price for their stock has risen an astounding
$61.94

Total Assets Net Sales Sales Growth

2002 77,359 99,049 -6.17%

2003 81,470 121,761 17.8%
2004 93,208 155,300 20.7%
2005 125,833 198,200 22%
2006 132,628 210,118 5.5%
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 Industry Overview

Chevron considers its primary competitors to be the major international

integrated petroleum companies: ExxonMobil, Royal Dutch/Shell, BP, Valero, and
ConocoPhillips. Although Chevron is an international company, it also competes
with regional and independent companies such as Hess and Anadarko. In 2005,
the oil industry recorded revenues of $1.62 trillion, of which 81% was earned by
the five major integrated oil companies. Profits for the industry were $140
billion, 76% of that was earned by the top 5 oil companies. Exxon being the
largest company earned 25% out of the 76% profits earned overall. These top
five companies are the same ones that are Chevron’s main competitors.
This industry is highly concentrated, mainly because it is such a hard
industry to break into. The top 5 companies can set prices at a premium and still
have tall demands. Though on the other side there is a bit of price undermining
to increase traffic at their pumps. What these companies have to really compete
on is cutting costs, and figuring out more efficient ways of refining oil, producing
it, and shipping it.
What really makes this industry so unique are the high barriers to entry
and the high firm switching costs. For a new business to enter the market they
would either need lots of money to invest right away, or millions of people to
believe in the company and buy stock. Neither one seems very practical in the
oil industry with such superpowers already in control. As hard as it is to break
into the industry it is almost even harder to break out. The high tech machinery
and the unique process of refining oil cannot really be transmuted to function for
the creation of a different service or product.

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 Five Forces Model

The five forces model is a framework that analysts use to evaluate the
interior factors affecting competition and the external factors affecting bargaining
power. This helps to understand the industry and what strategies are needed to
gain a competitive advantage. The interior factors of the industry are defined
through the rivalry of existing firms, the threat of new entrants, and the threat of
substitute products. External factors are seen through the bargaining power of
customers and the bargaining power of suppliers. The five forces model is a
definitive look at the sources of competitive advantage in the industry and how
to maximize profits.

Oil and Gas Industry

Rivalry Among Existing Firms Low
Threat of New Entrants Very Low
Threat of Substitute Products Low
Bargaining Power of Buyers Low
Bargaining Power of Suppliers Moderate

Rivalry Among Existing Firms (Low)

The oil industry is unique from other industries due to the high demand
for oil and the market’s control of prices. There is relatively little competition
among the top corporations because these firms fight for market share by
acquiring assets. The top corporations have been in their respective positions for
many years with little change. The oil industry is considered to be in a
punctuated equilibrium in which the top corporations allow the market to control
prices and focus primarily on reducing costs through an efficient supply chain in
order to maximize profits. The industry’s existing firms operate in an
environment of slow industry growth, high concentration, low product

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differentiation, high switching costs, and large economies of scale. High variable
costs, large excess capacity, and high exit barriers also define the oil industry.

Industry Growth
The oil industry is characterized by stagnant growth with incumbent firms
acquiring smaller firms for their assets as soon as they gain any market share.
The sizes of the top existing firms are some of the largest in the world boasting
five corporations in the top ten worldwide. Most of the top corporations in the
industry have been conducting business for close to a century and continue to
lead the way. The path to growth in this industry is the acquisition of assets by
buying smaller firms, purchasing oil rigs, and expanding operations to find more
energy resources. Most stagnant industries are characterized by price wars, but
this is not the case for oil. The price of oil is set by the market so firms must
focus on increasing the size and reach of their products while reducing costs.
Demand for oil will continue to grow as is seen with the 2.7% increase in the
U.S. alone last year. The oil industry will continue to grow at a slow and steady
rate as the world will continue to rely on oil first and foremost.

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Concentration
The degree of concentration in an industry determines the competitive
balance that influences price movements. An industry such as oil is considered
highly concentrated because there are six relatively equal sized players who take
up the extent of the market. A calculation done by the Census Bureau called the
industry concentration ratio shows that there is only a ten percent separation of
market share between the top firm and the fourth largest. This shows that there
is a high dispensation of revenues between these top firms. The acquisition of
smaller firms by the industrial giants is a common occurrence each year. In the
past twenty years, the top firms themselves have merged three times to create
even larger superpowers. While there are over twenty fully integrated oil and
gas companies, the size of the industry makes these smaller companies
inconsequential. The top ten corporations in the oil industry control over 90% of
the revenues coming in. Market share among the top corporations has remained
steady for the past five years as there have been no new major acquisitions.

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This market will continue to share its revenues and profits among the top five
firms while the rest are left to pick up the scraps.

Percentage Market Share

35
30
Exxon Mobil
25
RD Shell
20
BP
15
Chevron
10 ConocoPhillips
5 Valero
0
2002 2003 2004 2005 2006

Differentiation and Switching Costs

Oil is a commodity and therefore is not differentiated. Oil from one
company is the same as oil from any other company. Consumers can readily
choose any gas station to get their gas. Therefore, consumers have a very low
switching cost between different oil company’s products. Because price is not
controlled by the companies, they must find other ways to sell their product.
The oil industry combats this through the focus on cleaner, more efficient fuel,
brand image, and gas cards that provide incentives for using their gas. The main
advantage firms can attain is through owning the most retail stores in the right
places. Thus, there are ways to differentiate the oil industry, but the
fundamentals of low differentiation and low switching costs remain.

Economies of Scale
The size of companies in the oil industry is imperative to their success.
The top four companies combined revenues is $1.145 trillion. The more assets a
company can acquire, the greater their success in the industry. The average
amount of capital the top firms own is $175.88 billion. This is an enormous scale
only comparable to the motor vehicle and banking industries. In terms of a

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learning economy, the oil industry’s upstream activities such as drilling and
refining are highly specialized. Many scientists and engineers are involved in the
processes the oil industry operates. Thus, there is an emphasis on intellectual
capital as well as enormous physical capital.

Total Revenue in billions

400
350
ExxonMobil
300
250 RD Shell
200 BP
150 Chevron
100
Conoco Phillips
50
Valero
0
2002 2003 2004 2005 2006

Fixed to Variable Costs

The fixed to variable costs ratio in the oil industry is very low with a great
amount of variable costs from the purchasing of crude oil and products. Oil
companies purchase oil from different countries, mainly those in OPEC, to fulfill
excess demand. This small percentage accounts for very high costs when there
is political and social unrest in that region. Variable costs account for over four
times the amount spent on fixed costs. This is a unique circumstance among
industries as most industries with a low ratio have more latitude to move to
other industries. High variable costs are just a product of the unique system that
is the oil industry.

Fixed to Variable Costs

2002 2003 2004 2005 2006

Chevron 0.209 0.181 0.212 0.185 0.223
ExxonMobil 0.131 0.123 0.107 0.09 0.095
ConocoPhillips 0.096 0.072 0.059 0.048 0.073
BP 0.088 0.164 0.148 0.123 0.116

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Excess Capacity
Excess capacity is as simple as supply and demand. When there is too
much supply, firms must cut prices to sell the product. In the oil industry, supply
is generally well above demand. Each company stores reserves in order to be
prepared for sudden increases in supply. Reserves are a positive attribute in the
oil industry as it proves the company is utilizing its resources. The oil companies
use resources such as OPEC to purchase oil when needed to fill demand at short
notice. This can lead to problems with gas prices when OPEC decides to cut
inventories.

Exit Barriers
Exit barriers are the hindrances to leaving a particular industry for another
industry or segment. Oil companies invest so much into capital and resources
that have no value as anything else that it makes it nearly impossible to exit the
industry. Oil rigs are a necessity in running a profitable petroleum company.
These structures are moveable and used for exploration and development. They
can cost anywhere between $90 million and $550 million to construct, depending
on the structure and the deepness of the water. Oil rigs have no inherent value
as anything other than an oil rig. If the resources it covers are dried up, then
the value of the rig is only scrap metal. Firms in the oil industry either last a
long time or are acquired by another corporation. The oil industry is highly
specialized, making an exit from the industry implausible.

Conclusion
The oil industry continues to be one of the most watched and powerful
industries in the world. Its slow growth, high concentration, low differentiation,
and large scale have been the custom for many years. These factors have led
the leaders among the industry to continue to bring in record profits and
continue to acquire new assets at will without a great deal of competitive rivalry
between them.

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Threat of New Entrants (Very Low)
The oil industry is one of the longest standing industries in the world. A
high concentration of enormous firms with relatively equal market share and
billions of assets make the threat of new entrants negligible. The industrial
giants have retained their position among the elite for many years and swallow
up any competitor who threatens to take from their profits. The survival of any
new entrant is unlikely due to immense economies of scale, first mover
advantage, and legal barriers. These factors account for the near impossible
movement into the stagnant oil industry for new firms.

Economies of Scale
As mentioned before, the oil industry is huge and well paid. A new
company would have to have extremely deep pockets in order to even purchase
one oil rig. Whereas the largest oil companies own over twenty. Such capital
takes decades of profits and accumulation of resources to begin to make a dent
in the market for oil. The oil industry is characterized by who is the biggest and
most efficient. Economists use a term called the minimum efficient scale to
assess the point at which costs are a minimum for a company. The entry unit
cost is the price at which a company must pay to enter into an industry. The
greater this gap, the higher the barrier to entry. The entry unit cost for the oil
industry is one billion dollars. The minimum efficient scale is around twenty
billion dollars. Thus, entering the industry is attainable. While becoming an
efficient contender would involve the company expanding twenty times over or
2000%. The scope of the oil industry is so vast, which is why no new entrants
have been able to make a mark for over fifty years.

First Mover Advantage

The superpower oil companies have an extreme advantage over new
entrants in that they have set the standards for all oil companies to come. Major

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oil companies have assets all over the world and work with over one hundred
nations to acquire their resources. The top oil companies have worked with
these countries for decades forming alliances imperative to efficient production
and sales. By being the first and most powerful companies in these areas, new
entrants will have trouble breaking into these markets and using their resources.

Legal Barriers
There are many rules and regulations that govern such an important
industry. A company must be responsible for the valuable resources it handles
and the countries it deals with. This can be a significant obstacle for new
entrants into the oil industry. Many things must be taken into account when
working with other countries. These countries are very protective of their
resources and not any firm can attain them at will. These legal barriers can be
costly and time consuming for a firm that is trying to earn profits quickly and
efficiently.

Conclusion
Overall, the threat of new entrants is extremely low as is seen by the
absence of new companies. It is too much to ask for a company to compete
with an economy of that scale. These companies that have been around for
almost a century have set their own standards for how the industry is run and
how to get around legal barriers. It is unlikely that any company who begins to
earn market share will be able to earn sustainable profits without being acquired
by a larger corporation.

Threat of Substitute Products (Low)

The threat of substitute products has become a big issue for the oil
industry in recent years. Environmentalists have become very vocal about the
problems burning fossil fuels create. Other energy sources such as solar, wind,

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nuclear, biofuel, hydrogen, and electricity are all seen as possible substitutes for
oil and gas. While there has been little change, the movement is beginning to
take effect with the popularity of hybrid cars and focus on biofuel. Over 90% of
the energy sources used today are from fossil fuels and this will be the case for
many years to come. The threat of substitute products to the oil industry is low
but may see slight increases in the near future.

Relative Price and Performance

The price of oil is one of the most followed figures in people’s daily lives.
As a commodity, the market continues to price the cost of fuel. Thus, the lower
the price, the same quality fuel. Contrary to popular belief, oil is still the
cheapest and most efficient form of fuel the world has. The turn towards biofuel
provides consumers with a more expensive and less efficient fuel, but one that is
better for the environment. Others methods of energy are too costly and
unstable to be considered. Thus, the world has stuck to oil as the king of fuels.
No matter the price, consumer demand has stayed stable for gasoline. People
have to go places and oil is the most efficient and least costly way to do it.

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Buyers’ Willingness to Switch
Buyers are still not ready to switch to alternative forms of energy. It is
what they have done for decades and the other alternatives are not conceivable
at this point. The main method buyers have used to switch away from its
dependence on gas is hybrids. These cars increase gas mileage and therefore
burn less fuel. Sales of hybrid cars are still abysmal compared to regular new car
sales, but they are making a dent. Consumers are not ready for solar energy, or
more expensive and less efficient biofuel. Oil is as highly demanded as ever and
it will take a great degree more technology before consumers begin to make an
impact.

U.S. Energy Consumption by Fuel (1980-2030)

Source: U.S. Dept. of Energy

Conclusion
The oil industry has come under fire in recent years but remains the most
powerful and profitable industry. The threat of substitute products is minimal at
this point, but one big invention could change that course in the future. Until
then, the threat of alternative energy sources remains small. While biofuel and
hybrid cars will continue to make a small impact in consumer demand for oil.

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Bargaining Power of Customers (Low)
Customers and their bargaining power over the firm can have a huge
impact on its business strategy. High bargaining power leads to a greater
control over price. While low bargaining power has typically no effect on price.
The oil industry represents the latter case. Consumers rely so heavily on the oil
industry to fuel their cars and heat their homes that they have no choice but to
consume oil or rely on other costly forms of energy.

Price Sensitivity
Consumers are generally very price sensitive to commodities. When the
price of corn increases, consumers move to another cheaper commodity such as
green beans. This is not the case in the oil industry as consumers are almost
exclusively dependent on the resource. The cost of switching to another energy
source is very high, which is why demand has remained constant even as the
price of oil has increased. The threshold for prices has not yet been reached but
each year since 2001 has seen a large increase in the price of oil. At some point,
the price will become so high as to deter consumers from buying it or the
government will have to step in to lower prices to equilibrium. Consumers in the
oil industry have expressed outrage at high gas prices, but nothing will change
until demand is decreased. Thus, the consumers of oil around the world have
low price sensitivity due to their endless demand for the product.

Relative Bargaining Power

Bargaining power is the cost of one party not doing business with the
other. The extent of consumers around the world who consume oil and gasoline
on a daily basis exercise little power over the price they pay. With a consumer
base of that magnitude, the potential for bargaining power is enormous. The
dependence on oil and gas for these consumers is too great to exercise that
power. Consumers have attempted in the past to drive down the price of oil by

21
arranging boycotts of gasoline for a day. This is not nearly enough to make any
impact as people still drive the same amount and are forced to buy their gas
eventually. The movement away from high demand of gas is the best bet for
driving down price, but as the world moves faster, demand only increases.
Buying hybrid cars, using other forms of energy, and decreasing the amount of
driving are consumer’s main tools for combating high prices. The government is
the best agent with the capability to drive prices down. Thus, consumers can
bargain by electing certain officials and pressuring them make oil companies
drive down prices. There has been some legislation in the past to deter price
gouging and ensure ample supply for the U.S. This will be the quickest route if
any major changes are to be made.

Conclusion
The bargaining power of customers in the oil industry relies on the
individual. With such a large industry of billions of consumers, it would take a
full scale revolution to change demand and price. This is why the government
has the most power to make changes that could lower price. With consumers
being very insensitive to prices, there is no threat of change in the near future.
Consumers must change their driving and energy habits on a large scale in order
to affect the market. The firms in the oil industry have the power to keep prices
high and earn large profits without any decrease in demand. At what price oil
must reach before a change is made remains to be seen.

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 Historical Gas Prices (Adjusted for inflation) Price Per Gallon
Source: U.S. Doe

$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
$0.00
1950

1955

1960

1965

1970
1975

1980

1985

1990
1995

2001

2002

2003
2004

2005

2006

2007
Bargaining Power of Suppliers (Moderate)
The oil industry is one of the most powerful in the world because of its
size and scope. Integrated oil companies control each aspect of the supply chain
in order to keep it efficient. Oil companies control how they explore, produce,
refine, and market their resources. This is key in controlling any bargaining
power that would come about. The only real supplier of oil to these companies
is the purchase of oil reserves from oil producing countries. These reserves
make up 10% of the oil corporations distribute but have a huge effect on price.
The Organization of Petroleum Exporting Countries sets price upon their proven
reserves and possible political or social unrest. Therefore, suppliers in the form
of countries have a high bargaining power even though they only supply a small
percentage of oil. Without those reserves, the process becomes less efficient
and much more costly to the firm.

Conclusion
The bargaining power of suppliers is seen by the control these countries
have over price. Integrated oil companies ensure low costs and a successful
supply chain by owning each part of the process. There will always be the risk of

23
OPEC pulling back its reserves if relations become strained. Thus, there is a
moderate power that suppliers have over the major oil corporations and their
prices.

Overall Conclusion
The five forces model gives a detailed picture into what drives a firm
within the industry and what external factors affect it. The competition in the
industry overall is considered low. While highly concentrated, the industry’s
superpowers do not have price wars, or struggle for market share. Market
share, revenues, profits, and prices rise and fall as a unit with no new players to
deal with. The term punctuated equilibrium describes it best as a state of
stability among firms with the same goals. The oil industry has continued to
operate in the same way that it has for a century and shows no sign of budging.

24
 Value Creation in the Industry

The creation of value in one of the largest and oldest industries in the
world has not changed since its inception in the late 19th century. The monopoly
that was Standard Oil swallowed up smaller companies at will and became one of
the most profitable companies of all time. After being split up in 1911, it is now
represented by five of the top six oil companies in the world. The idea that
bigger is better is proven by the domination of a small number of enormous
firms fighting for the acquisition of assets. The petroleum industry relies on
attaining cost leadership for its competitive advantage. With no power over
price, these corporations must reduce costs in order to maximize profits. Oil
companies operate in a punctuated equilibrium in which prices are an effect of
the market and not the individual company. It is on the corporation’s shoulders
to reduce costs and gain assets in order to achieve a competitive advantage.
There is a small emphasis on differentiation that has become more important in
maximizing profits as these companies expand their brand image. Oil is the most
heavily demanded commodity in the world and the most readily available. The
industry is characterized by its low rivalry among existing firms, negligible threat
of new entrants and substitute products, and low bargaining power of buyers
and suppliers.

Success Factors for Competitive Advantage

Economies of Scale and Scope
Corporations in the oil industry begin their pursuit for higher profits
through the acquisition of assets to achieve economies of scale and scope. The
top five corporations own an average of $176 billion worth of capital all over the
world. It is seemingly impossible for any new corporation to have deep enough
pockets to enter an industry of this size and scope. As new companies acquire
assets, the larger firms usually buy them out in order to expand their asset base.

25
Even the merging of the largest players in the industry is commonplace as seen
in the mergers of Exxon with Mobil, Chevron with Texaco, and Conoco with
Phillips. These oil companies are finding new ways to find oil where no one else
can reach while doing it more efficiently and more often. The pursuit of oil is
constant and far reaching. In other industries, inventories are seen as a burden
while oil reserves are a must for increasing shareholder value and profits.

Lower Input Costs

The price of oil is one factor these corporations cannot control. Therefore,
the greatest way to make more profits over the other competitors is through
reducing cost. For every one dollar the price per barrel increases, earnings for
each of the top five corporations increases by $500 million. Thus, the lower each
corporation can keep their expenses, the higher their profits are going to be.
The top corporations integrate the process from top to bottom in order to keep
total production costs down. Efficient production and distribution, otherwise
known as upstream and downstream, are major factors in keeping those costs
down. The largest corporations in the industry own their own oil rigs or share
them in order to reduce the cost of dealing with a third party and their
bargaining power. By owning these rigs, they have the rights to all of the oil
they can acquire. Major players in the industry pump on average over one billion
barrels of oil per year all over the world. Thus, low-cost distribution is extremely
important in keeping costs down. Those one billion barrels of oil must be
transported all over the world by tanker and truck to get to the consumer. Oil
tanker spills are a testament to the devastation to the environment and to a
company’s bottom line that can occur if corporations are not careful with their
distribution. Exxon had to pay $4.5 billion in damages as well as losing 11 million
gallons of oil in the Exxon Valdez oil spill.

26
Differentiation
There is a large emphasis on the investment in research and development
to make cleaner, more efficient fuel at a lower cost. This is one of the only
forms of product differentiation the oil industry can achieve besides brand image
and access to its product. There has also been a movement toward exploring
other forms of energy for use in the future as the world slowly moves away from
oil. Most of the oil industry already owns many of the patents that will be used
in place of oil later this century. There is also a new focus on the quality of gas
that companies are providing. Cleaner burning fuel is much better for a car’s
engine and may actually improve its performance. Integrated oil companies are
also differentiating through the use of gas cards. These provide incentives to the
consumer for using a certain gas company and have proven very successful in
creating brand loyalty. The main way these corporations set themselves apart is
being in the right place. Owning gas stations in high traffic areas that are easily
accessible and provide other needs such as good food is an important aspect to
improving profits and brand image.

Conclusion
No other industry boasts having its five top competitors in the top ten
largest corporations in the world. These corporations only fight is over the
acquisition of assets by building new oil rigs, finding new ways to attain oil, and
acquiring other companies and their assets. Movements in price are
uncontrollable for oil companies so profits are derived from cost leadership. The
corporation who can efficiently use their assets at the lowest cost will profit the
most. The corporations who lead this industry have been doing it for many
years which is why they are also the most profitable corporations in the world.
By mixing cost leadership with some product differentiation, these companies
can maximize profits. Demand for oil is a constant in our society and will be for
some time to come.

27
 Value Creation of the Firm

Chevron Corporation continues to be a leader in all aspects of the

industry. Chevron is adding to its value by continuing to expand its assets all
over the world, and creating a more efficient process upstream and downstream.
By focusing on economies of scale and scope, lower input costs, and
differentiation, Chevron creates value for the firm. Chevron is exemplary in its
control of cost leadership in the industry.

Economies of Scale and Scope

Chevron has enormous size and scope, which is why it is the fourth
largest corporation in the United States and the ninth in the world. Chevron’s
main assets are 19 fuel refineries and an asphalt plant. That number will be
growing with its acquisition of a stake in Reliance Petroleum Limited and its state
of the art Jack #2 well that can drill under 7,000 feet of water and 20,000 feet of
sea floor. The company continues to expand as is seen from a 13.8% return on
its capital over the last year and $27 billion market value added over its capital
invested. Thus, the money they are investing in capital is providing them with
profits very quickly. There is still a lot of room to grow as is seen by
ExxonMobil’s market value added of $200 billion, but still better than Royal Dutch
Shell and ConocoPhillips. With the acquisition of Unocal in 2005, Chevron is still
in the process of adapting their assets to make them more efficient and
profitable. Chevron is also heavily focused on research and development,
investing $468 million last year. This will help provide more efficient refining
processes and new frontiers in oil rigging such as the Jack #2. On the
downstream side, Chevron has continued to expand its retail sites in over 90
countries to 25,800 from 20,354 two years ago. It is imperative that Chevron
continue to grow in order to keep up, if not overtake the other major firms in the
industry worldwide.

28
Lower Input Costs
Chevron is very successful in keeping costs low as is seen by its profits.
With the price of oil up, Chevron has continued to bring in profits and keep up
with consumer demand while keeping costs low. By handling both upstream and
downstream operations, Chevron is able to control their destiny in each step of
the value chain. With the price of oil way up over the past five years, Chevron
has been rapidly expanding while they have plenty of cash to work with. If
prices were to plummet, Chevron would have enough cash on hand to survive
and possibly buy out defaulting companies. By keeping costs as low as possible,
profits come easily. New technology from investments in research and
development has led to the automation of many of the previous jobs on oil rigs.
Chevron has been able to cut its work force by one-fifth on oil refineries reducing
costs and increasing efficiency. This is why Chevron is the seventh most
profitable corporation in the country. Chevron has continued to be one of the
leaders in the oil industry by repeating their cost leadership strategy over and
over. Low-distribution costs, efficient drilling and refining, and low overhead are
all keys to the success of Chevron.

Differentiation
The oil industry is unique in that it is the only commodity based industry
to have to employ product differentiation. Because oil is in such high demand, it
is imperative that each company set itself apart. Chevron is known for its
inclusion of Techron in its gasoline. Techron removes sulphur and other deposits
from accumulating in the engine. The move toward cleaner, higher quality fuel
has become very important to consumers in recent years. Knowledge that
Techron lengthens the life of a car is very important to most consumers.
Chevron is also one of the main companies to offer gas cards and gift cards for
their gasoline. This builds up product loyalty and gives incentives to consumers
to use their gasoline when possible. Chevron has also commercialized their

29
brand with the ad campaign using talking cars. These humorous commercials
produced a friendly image of the company that is easily recognizable. Lastly, the
greatest advantage a gas company can have is positioning. By placing a
Chevron in the highest traffic areas that are easily accessible and customer
friendly, Chevron is selling more product to more people.

Future Competitive Advantage

Chevron has been making money the same way for close to a century and
will continue to revolutionize the industry. With new acquisitions every year,
new technology, more efficient and cost effective methods, and increasing
product differentiation, Chevron will continue to increase profits. As the
movement from oil and gas nears, Chevron is in the process of researching other
forms of energy and gathering their patents in order to continue to fuel
consumer’s cars and houses among other things. The future of Chevron looks
bright as it continues to earn amazing profits and move toward the future.

30
 Formal Accounting Analysis

Identify Key Accounting Policies

The financial statements are a window for shareholders to see what the
value of the company is and the direction it is heading. Companies can use this
to their advantage by manipulating certain aspects of each statement to reflect
their purpose. Thus, the analyst must be skeptical in their analysis of a
company’s financial statements. Each company has certain key success factors
that increase the value of the firm. It is these factors that must be evaluated
through the financial statements to assess the true value of the firm. Chevron
relies on economies of scale, low input costs, and the acquisition of assets to
create a competitive advantage and increase the value of the firm. Chevron
operates in an industry of cost leadership in which integrated oil companies
increase profits through decreasing costs and acquiring assets. The price of oil is
a constant, therefore it is imperative that oil and gas companies decrease costs
and increase their assets to profit. The financial statements give the clearest
view investors have into the workings of the company and how these key
success factors are creating value. Managers have the ability to manipulate the
financial statements in their favor using the flexibility of generally accepted
accounting principles (GAAP). By utilizing financial flexibility, managers can
ensure that any figures critical to its key success factors will be portrayed
advantageously. The following accounting policies help Chevron maximize value
and maintain a competitive advantage.

Reserve Estimates
Chevron uses a great deal of estimates and assumptions due to the
scarcity of oil and natural gas compared to a company who has readily available

31
materials. An integrated oil company is valued based in part on its ability to find
and extract oil and natural gas. The estimation of crude oil reserves must be
done with reasonable certainty according to the SEC. Chevron must perform
tests in order to ascertain the amount of crude oil that can be extracted in future
years at current prices. These are known as leasehold acquisition costs and are
expensed on the income statement similar to research and development for
other companies. Through exploration, Chevron is able to acquire more crude oil
to be distributed and held as reserves which constitute a key success factor in
the industry. Chevron must keep excess reserves for in the case of a shortage,
and to hedge against the possibility that oil prices skyrocket. A close estimate of
oil and natural gas is essential to the timing of expense recognition and the
valuation of the firm as a market leader. Chevron must be able to explore and
acquire reserves on schedule with their estimates in order to be efficient. They
spend a large sum of money on equipment, research, and exploration in order to
get a near exact estimate.

Goodwill
When a company acquires another, such as Chevron’s purchase of Unocal
in 2005, the intangible asset goodwill is reflected on the balance sheet. This
represents the amount paid for the company over its book value. This is
because each company comes with a reputation, patents, and other intangibles
not accounted for in the purchase. Accounting rules and regulations do not
require companies to amortize goodwill, thus providing Chevron with an
indefinite increase to total assets. Each year Chevron must determine whether
goodwill has been impaired and make adjustments as necessary. This gives
companies a great deal of power to either retain goodwill at the present state or
to write it off if the situation arises. Chevron’s purchase of Unocal netted $4.636
billion in goodwill for the year 2005. This is a substantial amount considering
total inventories on the balance sheet were $4.121 billion. A decrease of $13
million in 2006 to $4.623 billion is only a 2.6% drop and would take just over 38

32
years to be reduced to zero at that rate for Unocal alone. That being said,
Chevron has relatively little goodwill compared to others in the industry such as
ConocoPhillips at $31.488 billion after the merger of the two companies and
$10.78 billion for BP. ExxonMobil carries no goodwill on the balance sheet which
is quite a disparity from the rest of the industry. A $26.865 billion difference
between Chevron and ConocoPhillips is a material difference that could mislead
investors as to the true value of each firm.

Operating Leases
The use of operating leases allows companies to lease assets instead of
capitalizing them on the balance sheet. Typical assets Chevron leases for short-
term use are tankers, production and processing equipment, service stations,
and other facilities. Managers have some flexibility in deciding whether to
capitalize these leases or continue to leave them out. Chevron had slightly over
$3 billion in operating leases compared to $888 million in capital leases at year
end 2006. With total liabilities at $28 billion, $3 billion dollars in operating leases
is a significant number. $274 million of operating leases were switched over and
capitalized in the same year. All integrated oil companies use this strategy to
their advantage and it can seriously effect the company’s financial statements.

Pension and Post-Retirement Benefit Plans

Pension and other post-retirement benefit plans play a role in the validity
of expenses for the company. Chevron must estimate the long-term rate of
return as well as the discount rate applied to pension plan obligations. The total
pension liability for Chevron in 2006 was $1.7 billion. A 0.25% change in the
discount rate can have an effect of over $275 million. Chevron must ensure that
the expected long-term rate of return and the discount rate are close to their
actual amounts in order to be prepared for those costs if under-funded.

33
Conclusion
Chevron has a great deal of variability within their financial statements.
What may seem like the fixing of numbers is a common strategy that firms must
be creative with to truly maximize value. The oil and gas industry only has a few
assumptions such as leasehold acquisitions, operating leases, and pension plans.
By using these to affect net income and other critical accounts, Chevron is able
to continue to entice investors to their stock.

Accounting Flexibility

There are many estimates and assumptions in the application of generally

accepted accounting principles (GAAP) that managers use when preparing the
financial statements. This can have a material impact on how the company’s
economic situation is seen. Chevron exhibits a flexible accounting strategy
compared to most firms, but not to those in its industry. Looking at the history
of the largest oil and gas firms goes back to Standard Oil when they all were
formed as one corporation. Obviously, the fundamentals and strategies remain
the same in this unique industry. These firms have the leeway and ability to
capitalize on the flexibility provided them. There is no way to materially alter
financial statement line items, but there are steps to give them a slight
advantage across industries or against less enlightened competitors.

Leasehold Acquisitions
The flexibility among leasehold acquisitions is one that has future impacts.
Reserves play a huge part in the valuation of oil and gas firms to the point that
they are some of the first and most recurring numbers in the financial
statements. Analysts focus on the replenishment of crude oil which is what
percentage over the previous year’s reserves this year has brought in. Chevron

34
came in lower than expected with 102%. Competitors ExxonMobil and Shell
were able to bring in 120% of last years oil. Investors are not happy when
reserves are not as high as expected which all goes back to the leasehold
acquisition estimate. Every company will have a down year, but a variable like
reserves must be as close as possible to add value to the firm.

Operating Leases
Chevron’s use of flexibility with operating leases is much the same as the
other large oil and gas corporations. There are benefits to being able to lease
certain assets instead of paying the price and depreciating it. Operating leases
represent a large portion of the financial statements and play a large role in day-
to-day operations. The flexibility lies on how long a company uses the asset and
whether it really deserves that distinction. While operating leases may cost
more, it is often seen more beneficent to snare investors when your pockets are
very deep. Operating leases are a luxury for the companies to have that can
also be bended to affect financial statements.

Goodwill
Goodwill allows for flexibility by giving the company an option to impair
goodwill at the end of the year or leave it alone. Companies can use goodwill to
inflate the balance sheet’s assets and possibly decrease them if need be. This
gives Chevron’s management greater accounting flexibility.

Pensions and Post-Retirement Benefit Plans

A much smaller but very important aspect of the financial statements
deals with the money retired workers are due to receive. Managers must choose
a proper discount rate and expected rate of return in order to correctly estimate
the expenses that will be due. Thus, managers decide on conservative estimates
and investments in order to defray any unwanted costs that could arise. The
three largest U.S. integrated oil companies of Chevron, ExxonMobil, and

35
ConocoPhillips all use relatively the same rates. The assumed rate is between
5.5% and 7% while expected return is slightly higher at 7.5% to 8%. Such a
large expense must be dealt with conservatively in order to avoid any excessive
costs that might result from the market.

Conclusion
Every company can decide their own level of flexibility. By keeping
estimates conservative, Chevron is able to avoid excess costs which is one of the
key success factors. A little more hidden options such as leasehold acquisitions
allow the firm to really make their financial statements more attractive to
investors. The financial statements are the window that millions of people look
at and evaluate. Chevron uses some flexibility to their advantage, but their 10-K
is very open about how that affects the company.

Accounting Strategy

Chevron as well as their competitors must have their financial statements

in accordance with generally accepted accounting principles. They use
accounting flexibility to make estimates and assumptions in reporting their
financial information. After reviewing Chevron’s financial statements, it appears
that they use the same approach as other major oil and gas companies in their
accounting strategy.
Chevron’s main objective is to outperform their competitors by creating
value and having substantial returns. They use strategies such as upstream and
downstream and also invest in renewable energy technologies. As you can see
from Chevron’s operating numbers, there is an increase in certain costs in the
exploration and production of the company due to inflation in different areas of
the world. The oil and gas industry operations and profitability are influenced by
many different factors, several in which they have no control over. Some of

36
these factors include Governmental policies, supply and demand, and prices for
their commodities. Just like in 2005 with many of the hurricanes in the Gulf of
Mexico, the oil distillation capacity was down compared to the capacity in 2006.
Other instances that can shift financial reports are the different projects that the
company is undertaking, such as expanding refineries and research and
development.
In 2005, Chevron merged with Unocal and in Chevron’s financial
statements you can see how their assets, net income, and revenues have all
increased. For example, you can see how property, plant, and equipment rose
by almost 10% in 2006. This is due largely in part by the acquisition and their
operations in North America and Asia. Also as stated in Chevrons 10k;
operating, selling, general and administrative expenses in 2006 increased from
$17 billion to $19.7 billion, a 16 percent increase from the previous year. With
Unocal’s expenses added to the financial statements, expenses are much higher.
In their 10k, Chevron shows that from 2004 to 2005, total expenses are higher
due to Unocal’s expenses for five months due to labor, transportation, uninsured
costs from hurricanes in those current years, and asset write-offs. Therefore,
with the merging of these two companies it can explain many of the increases in
the financial statements.
Chevron uses the equity method in subsidiary companies and owned and
variable interest entities, in which they are the primary beneficiary. As stated by
Chevron, the company recognizes gains and losses that arise from the issuance
of stock which results in a change in the company’s income. Also subsequent
recoveries in the carrying value of other investments are reported in “other
comprehensive income.” This is important to Chevron because in owning more
of the company, they in turn will recognize more earnings. In there financial
statements it is noticeable how they have increased their retained earnings from
2005 to 2006 by approximately 23 percent.
Chevron uses their accounting strategy to best supply information about
the company. They are in accordance with the generally accepted accounting

37
principles but also use some flexibility to make estimates and assumptions. With
the current merge with Unocal you can see in their financial statements how
their assets, net income, and revenues have all increased.

Qualitative Analysis

Chevron’s financial statements are quite accessible and transparent when

trying to value the firm. They give an in depth look at their current activities for
investors. Along with the basic information that is consistent throughout the
three main financial statements they also offer vital ratios and charts. Looking at
their financial summary, Chevron offers a five year in depth coverage for their
financial ratios. These consisted of interest coverage, return on average
stockholder’s equity, return on capital employed, cash dividends/net income,
cash dividends/cash from operations, total stockholder return, and return on
average total assets. On Chevron’s consolidated Income Statement they provide
the in-depth recordings of their revenues and other income and also the
information on what fuels and refined products bring in the most revenue. On
top of this they provide their total upstream (exploration, development and
production) and downstream (refining/supply, fuels marketing, lubricants and
specialties) figures. Looking more closely at there Statement of Cash Flows,
Chevron provides not only information on where their operating and investing
activities were spent but also how they were spent.

Chevron’s increase in working capital was not only listed as $1.044 billion,
but also shows where each portion was used. The decrease in Chevron’s
account/notes receivable, inventories, and prepaid expenses and other current
assets consisted of a $550 million decrease, but their increase in accounts
payable and accrued liabilities increased by $1.246 billion. This provides readers
with the financial statements an exact idea as to why working capital has raised

38
an extensive amount. Chevron applies the same depth throughout the cash
flows statement. Looking at their investing activities, Chevron shows how the
capital expenditures were allocated portion by portion. What is interesting as
well is that some of the more important segments recorded in the Balance sheet
are actually explained more in depth.

Highlights
I think Chevron provides an important overview of their strengths. It
allows readers a quick glance study of how Chevron is improving its competitive
advantage. The section first gives the industry conditions of the current year,
giving information on territorial economic productions and how the oil in that
region relates to the market. They then give a quick overall business strategies
section that allow readers a summary of what areas Chevron is really trying to
succeed in and how. The end section provides their current year
accomplishments to induce investors into investing with the company.

Upstream & Downstream

With an industry that is valued mainly on how costs and revenues are
incurred through subjective reporting, it is important that these companies
accurately record every activity. Something that is distinctly different from
Chevron compared to its competitors is how they extensively explain their
upstream and downstream process. About ten solid pages throughout their
financial statements discuss their strategies, competitive advantages, operating
efficiencies, integration, market growth and many more. This allows investors a
transparent look at how Chevron is allocating many of their resources and
investments to provide revenues, which is a key success factor in the industry.
For example, the Properties, Plant and Equipment figure of $137.747 billion is
broken away from the statement and given its own section that provides more
information. As you can see this is very vital for readers to keep track of

39
Chevron’s long term assets. On top of this separation of PP&E, Chevron gives an
asterisk on the sub categories labeling them with a number. Then you can scroll
down to the bottom of the page and check a bit more in depth what that
category is actually stating. Along with this, every financial statement provided
by Chevron has these asterisks to better inform the reader.

Quantitative Analysis

Using the sales and expense manipulation diagnostic we can better assess and
evaluate Chevron, Exxon, ConocoPhillips, Shell, and BP. Using these ratios we
will assess whether Chevron and its competitors are using appropriate
accounting policies, and whether or not they are not just trying to inflate
revenues for the period. Through the accounting policy flexibility, these firms
could be tempted to distort their information to better appeal to investors.
Trying to locate “red flags” in an industry can be difficult if we do not dissect
their financial information properly and accurately.

Sales Manipulation Diagnostic

This is the basis for firms to inflate their revenues and falsely report
numbers. Thus, we are looking to see if the companies are manipulating their
sales which would affect profits and other key values. Looking at the sales ratios
we will better understand the underlying meaning behind net sales and the
denominator of cash from sales, accounts receivable, unearned revenue,
warranty liabilities, and inventory.

40
Net Sales/Cash from Sales

Net Sales/Cash from Sales

1.4

1.2

1 Chevron
Exxon
0.8
ratios

Conoco
0.6
Shell
0.4 BP

0.2

0
2002 2003 2004 2005 2006
years

This ratio represents key points on the money merry-go-round. When a

company sells a product, the goal is to receive cash in return. As we can see
here Exxon, ConocoPhillips, and Chevron all have a close relation in their ratios,
and they are all closest to one which is the ideal ratio to have. Anything higher
than one means you are not receiving all that is due and therefore not
maximizing value. Chevron is in a good position at just over one which is
attributable to delinquent accounts. This is unavoidable with receivables but
looking at Chevron’s location compared to its competitors Shell and BP, Chevron
is gaining a slight advantage. This ratio should correlate with the receivables
ratio to be looked at next. Altogether, these numbers are consistent with where
they should and no manipulation has taken place.

41
Net Sales/Net Accounts Receivables

Net Sales/Net Accounts Receivable

25

20
Chevron

15 Exxon
Ratios

Conoco
10 Shell
BP
5

0
2002 2003 2004 2005 2006
Years

Net sales compared to accounts receivable looks at the disparity and

consistency of sales on account. Oil and gas companies do not earn most of
their money from receivables like the retail industry, but do receive a significant
amount at gas stations. Chevron remains relatively consistent and is earning a
healthy amount of sales straight to cash. It is better to have the money in hand
than to rely on receivables as is seen in the cash from sales ratio.
The rest of the industry has some subtle variability but each has found a
niche for where they feel comfortable or where they are trying to take the
company. A lower ratio could mean a focus on increasing receivables, or a
change in who is buying their product. Shell and BP are putting themselves at a
disadvantage in the long run because too much accounts receivable hurts cash
from sales. Chevron is in a good position and reflects the cash from sales ratio
which should correlate with movements in the sales to receivables ratio. In this
case, both remain consistent and do not exhibit signs of manipulation.

42
Net Sales/Unearned Revenues

80

70

60
Chevron
50 Exxon
40 Conoco

30 Shell
BP
20

10

0
2002 2003 2004 2005 2006

This ratio looks at the net sales earned by the company against revenues
that have yet to be earned. For oil and gas companies, these are contracts with
petroleum companies and countries who wish to buy oil from the company.
Thus, companies like Chevron receive revenue from which the contract has not
yet been fulfilled. Looking at Chevron, they have fairly recorded their unearned
revenues steadily and consistently throughout the five years. On the other hand,
BP seems to have the most volatility in their recordings. This can be a result of
manipulating unearned revenues to inflate sales, or a large scale change that
affected contracts. Manipulating unearned revenues usually consists of
recognizing them early in order to increase revenues. This is hard to say in this
industry where demand is so volatile. The large increase in 2005 for Chevron
may have a lot to do with their purchase of Unocal and any contracts that came
with it while sales took longer to make an impact.

43
Net Sales/Inventory

Net Sales/Inventory

60

50
Chevron
40
Exxon
Ratios

30 Conoco
Shell
20
Bp
10

0
2002 2003 2004 2005 2006
Years

This ratio shows whether inventory supply is on track with sales. We

examine Chevron’s inventory turnover compared to its investors, and it seems
that they have a longer period of turnover compared to its competitors. This is a
negative reflection upon Chevron. Keeping large amounts of inventory is very
important in the oil and gas industry. Companies must be prepared for sudden
surges in consumption or demand. It seems as though this is beginning to
decrease to healthier levels. Large and sudden drops can often be a red flag in
ratios like this so it seems the ConocoPhillips may have misrepresented
inventories in 2005. They could also have sold off a large amount of inventories
or oil rigs which would lead to an increase in sales and decrease in inventories.
Chevron has no signs of manipulation and is on the right track to increasing the
firm’s value.

Conclusion
Overall, Chevron has put itself in a good position relative to the industry
with their sales. All signs point to a clear and correct representation of sales,

44
cash from sales, receivables, unearned revenues, and inventories. The industry
is also properly represented with no reasons to suspect manipulation.

Expense Manipulation Diagnostic

Analyzing an individual firm’s expense manipulation is key to figuring out
whether or not the company is reducing expenses to increase revenues.
Comparing a single company to an industry though can explain a certain ratio
spike due to an outside force. We will analyze Chevron, Exxon, ConocoPhillips,
Shell, and BP using these expense ratios.

Asset Turnover

Asset Turnover

2
1.8
1.6
1.4 Chevron
1.2 Exxon
Ratios

1 Conoco
0.8 Shell
0.6 BP
0.4
0.2
0
2002 2003 2004 2005 2006
Years

Asset turnover looks at how productively the company is using their

assets. Productive asset turnover can increase the value of the firm. The
company’s ratios show a slow and steady increase over time which means they
are using their assets to better increase sales. Chevron shows the same
increasing trend 2004 and then a decrease in 2005 as is seen in each previous
ratio. This has to do with the purchase of Unocal in 2005 which greatly
increased sales and inventory, but profits take more time to start up. Once the

45
new asset is in place we see a small increase in 2006. ConocoPhillips has a
steeper slope until about 2005 when it drops dramatically by 32%. This
represents that ConocoPhillips was not fully valuing their assets correctly by over
valuing depreciation expense. From 2005 to 2006 ConocoPhillips’ depreciation
expense dropped a drastic 42% from 7,284 to 4,253 million dollars.
Overall, asset turnover is a very important ratio when valuing the
profitability of the firm. Once Chevron’s investment begins to work for the
company, this number will continue to climb and make the company more
valuable.

Cash Flows from Operating Activities/Operating Income

Cash flows from Operating Activities/Operating Income

2.5
Chevron
2
Exxon
Ratios

1.5 Conoco
Shell
1
BP
0.5

0
2002 2003 2004 2005 2006
Years

This ratio shows the relation between cash flows from operations and
operating income. This number should be low to show that operating activities
are higher than financing and investing activities. A company must generate
enough operating income to support its cash flows. Chevron seems to follow the
same trend as every other company except shell in this ratio. An increase in
operating income for each company was suddenly and emphatically realized
leading to a lower ratio. Chevron realized a 26% increase in sales in 2002 which

46
would increase operating income immensely and decrease the ratio. Thus, no
manipulation of expenses is necessary to produce such a large change.

Cash Flows from Operating Activities/Net Operating Assets

Cash Flow s from Operating Activities/Net Operating Assets

0.6
0.5 Chevron
0.4 Exxon
Ratios

0.3 Conoco
0.2 Shell

0.1 BP

0
2002 2003 2004 2005 2006
Years

This ratio shows the link between assets and generating cash flows.
Efficient use of assets will create higher cash flows from operations. Thus, the
higher the ratio, the more efficient the company. Chevron seems to remain
steady, once again reflecting the Unocal purchase in 2005 with a lower ratio in
2006. The steady state of Chevron makes it easier to predict the direction of the
firm. Overall, Chevron remains consistent across all ratios in the same manner
creating confidence in their financial results.

47
Pension Expense/SG&A

Pension Expense/SG&A

1.6
1.4
1.2 Chevron
1 Exxon
Ratios

0.8 Conoco
0.6 Shell
0.4 BP
0.2
0
2002 2003 2004 2005 2006
Years

We analyze this graph by explaining how much the companies are

spending on their retirees. The lower the number the better results for allocating
pension expenses compared to operating expenses. All of the firms in this
industry keep a low ratio below one, which means that their pension expenses
make up a less significant amount of their operating expenses. Chevron remains
in the middle on this ratio which is beneficial to the company’s value. There are
no huge changes and a lot of focus is paid to pensions in the 10-K. There is no
reason to think these are being manipulated.

48
Other Employment Expenses/SG&A

Other Em ploym ent Expenses/SG&A

0.8 chevron
Exxon
0.6
Ratios

Conoco
0.4
Shell
0.2 BP

0
2002 2003 2004 2005 2006
Years

This ratio focuses on employee benefits as opposed to pensions. This

ratio is only slightly lower than pension expense to SG&A and still leaves no room
to assume foul play with the statements. This ratio is becoming increasingly
more important because of the focus on insurance, benefits, and the coming
retirement of the baby boomers. In the future this ratio may be more subject to
manipulation but does not represent a large enough segment to cause concern.

Conclusion
After analyzing all the ratios and companies we can see that many firms
change their accounting policies to inflate sales and revenues or to decrease
expenses. Using the sales and expense manipulation diagnostic we were able to
breakdown these numbers and actually see visually on graphs what the
companies are portraying. Chevron overall in this industry seems to practice fair
and consistent accounting policies, and this gives investors a sense of trust in the
company. As we could see BP was probably the most volatile line throughout
the ratios, implying that they inflate revenues and understate expenses to depict

49
better looking numbers. We also concluded that some spikes in the ratio lines
came from an industry change, as seen in the total accruals to change in sales
ratio.

Potential Red Flags

There are a number changes that occur within the financial statements
each year as the governing accounting bodies release new statements and the
company adapts to a changing world. Red flags are those changes that occur as
a major change without good reason. Some examples are large asset write-offs,
unusual accounting changes, fourth-quarter adjustments, and discrepancies
between reported income and tax income to name a few.
Chevron operates in much the same way it has for a century. Older
companies tend to be set in their ways and tend to be very careful with their
mode of operation. Chevron has used the LIFO inventory system for some time
and has had no prior history of faulty accounting. One possible problem with the
statements is their reluctance to amortize debt. Chevron does a yearly
assessment of the value of their purchase to decide how much it should be
reduced. Still, the only reductions are small and not often made. Even so, a
yearly look into the value of the acquisition makes a difference and must suffice
any red flags.
Chevron deals with a lot of risk as far as currencies, the use of derivatives,
and a heavy reliance on estimates and assumptions. While none of them are out
of the ordinary or a cause for a red flag, they must be addressed as a legitimate
cause for discussion. Exposure to these risks can be damaging for a firm if they
are not done right. In reviewing the financial statements, Chevron has a great
deal of experience and understanding of how to account for them. Derivatives
represent a tiny portion of money invested and some of the brightest minds are
able to produce great returns. These returns can be used to finance any other

50
areas where costs are rising or unexpected. A company of this size, with over
$17 billion in profits does not have to hide earnings, changes, or risks within the
financial statements to make money and add value.

Accounting Distortions

After reviewing Chevron’s financial statements, the only material matters

that have an effect on the financials is the lack of amortization of goodwill.
Chevron has the option to keep goodwill on the balance sheet or to amortize it
out over time. We feel that by keeping goodwill on the books, they are
overstating their assets. The current goodwill is valued at $4.623 billion. We
feel that fifteen years is more than enough time to amortize goodwill off of the
books. Thus, each year $308.2 million will be deducted off of the balance sheet.
Chevron is sure to purchase other companies as well and should amortize those
as they come up.

51
 Financial Analysis, Forecasts, and Cost of Capital

Financial Analysis
Over the years experts have developed ratios to analyze and compare
financial statements between competitors. These 14 assets breakdown into
three main categories: Liquidity Analysis, Profitability Analysis, and Capital
Structure Analysis. Understanding these ratios can help investors make an
education decision about the operations of the business. Using these ratios we
can compare Chevron to its four main competitors, and compare the profitability
and operations of each company.

Liquidity Analysis
Comparing five of the main liquidity ratios between the companies allows
the reader to analyze the amount of time it takes to cover its short term financial
obligations. Investors can use these ratios to asses the amount of risk that is
involved. The higher the liquidity ratio the more confident investors will be in
investing in that company, because this means the more assets the company
holds to cover its short term liabilities the more actual wealth in the company.

52
Current Ratio

Current Ratio

1.5 Exxon
Conoco Phillips
1 Shell
BP
0.5 Chevron

0
2002 2003 2004 2005 2006

Exxon 1.15 1.2 1.4 1.58 1.55

Conoco 0.85 0.8 0.96 0.92 0.95
Phillips
Shell 0.85 0.9 1.13 1.15 1.2
BP 0.97 0.91 0.97 1.05 0.99
Chevron 0.89 1.21 1.52 1.37 1.28
years

In 2002 Chevron compared to its competitors was lacking the current

asset coverage over its current liabilities. Chevron though throughout the four
years grew its ratio dramatically to outperform its competitors by 2006. Exxon
has always been the leading dog in the Oil Industry due to its dominance in the
market. They are the only ones that are really that close to having a current
ratio of two, which signifies that they have the current assets to actually cover
their current liabilities. This is very important in the Oil Industry considering the
low amount of current assets compared to the long term assets. Though what is
interesting about these companies’ current assets is that for all of them about
1/3rd is composed of Accounts Receivables, which is interesting to consider for
Exxon and Chevron who both have higher ratios then the other three firms. As
an investor I would look at the higher current ratios with caution as to where the
current assets are actually coming from, because personally I would like to see
more prepaid expenses and total inventory comprising of current assets.

53
Quick Asset Ratio

Quick Asset Ratio

2.50

2.00 Exxon
Conoco Phillips
1.50
Shell
1.00
BP
0.50 Chevron

0.00
2002 2003 2004 2005 2006

Exxon 2.04 1.68 1.18 0.79 0.56

Conoco Phillips 1.66 1.12 0.73 0.35 0.22
Shell 1.28 1.41 0.85 0.28 0.24
BP 1.38 1.28 0.73 0.35 0.35
Chevron 1.69 1.97 1.36 0.61 0.46
years

The Quick Asset Ratio, also known as the acid test ratio, gives us the
liquidity of current assets minus inventories divided by current liabilities. We
take out inventory in this ratio because it is the hardest to liquefy. This ratio
agrees with our current ratio that these five companies have lots of their current
assets tied up in accounts receivables. On average each company dropped in
this ratio by .2 compared to the current ratio, signifying that inventories for these
Oil Companies consists of a solid portion of current assets. Most of the lines in
fact follow the same pattern as the ratio above. The only real standout is Shell
which in 2002 had a very poor ratio of only .26, but then bounced back in four
years to become the third best ratio between these companies. I believe that
Shell had lots of their current assets wrapped up in inventories, because in the
current ratio they had a ratio of .85 in 2002. Well this makes sense because
over the years Shell has sold most of these inventories for accounts receivables,
which is why we see the leap in the quick asset ratio over the four years.

54
Accounts Receivables Turnover

Accounts receivable Turnover

16.00
14.00
12.00 Exxon
10.00 Conoco Phillips
8.00 Shell
6.00 BP
4.00 Chevron
2.00
0.00
2002 2003 2004 2005 2006

Exxon 9.50 9.75 11.49 13.06 12.63

Conoco Phillips 4.37 7.43 9.83 12.80 13.63
Shell 5.58 6.73 7.11 4.62 5.34
BP 9.29 7.02 6.17 6.98 8.15
Chevron 10.48 12.30 12.14 11.27 11.62
years

The accounts receivables turnover is computed by taking sales and

dividing it by A/R. This will explain how well the companies earn cash and how
well they collect their accounts receivables. The first company that stands out to
me is Conoco Phillips, in 2002 they had a ratio of only 4.37 which was the lowest
compared to there competitors. In four years Conoco’s accounts receivables
turnover ratio rose to an amazing 13.63 which is the highest in the industry. It is
better to have a higher ratio because it’s stating that there is $13.63 in cash for
every $1 in A/R. Conoco has kept about the same amount of accounts
receivables over the five year span but has drastically increased their sales.
Looking at Chevron and Shell who both have the same figures and curve,
but Chevron has the higher ratios, we can see that sometimes even though sales
are rising it doesn’t mean your receiving more cash. For these two companies
Sales rose at a steady rate of around 22-25%, but their A/R’s had rises anywhere
from 20-40%. Chevron and Shell both had a 38% increase in A/R’s between
years 2004-2005, which in turn dropped there ratios a significant amount.

55
Sales Outstanding

Sales Outstanding

100.00

80.00 Exxon

60.00 Conoco Phillips

Shell
40.00
BP

20.00 Chevron

0.00
2002 2003 2004 2005 2006

Exxon 38.44 37.43 31.78 27.95 28.91

Conoco Phillips 83.52 49.13 37.14 28.52 26.77
Shell 65.37 54.24 51.35 79.00 68.31
BP 39.31 52.02 59.14 52.31 44.77
Chevron 34.83 29.68 30.07 32.39 31.40
years

In the cash merry-go-round this is the second portion, which explains how
well a company can collect on their accounts receivables. This is very important
in the Oil Industry because of what we have talked about before; most of these
companies have a considerable amount of A/R’s. For all of these firms the ratio
is notably high, and this is explained because there is a large portion of money in
receivables. Exxon, Conoco, and Chevron have managed to average the lowest
ratio which is around 30 days. Conoco dropped this down by extensively
increasing their sales and keeping A/R constant over the past five years. This is
also explained in the accounts receivable turnover ratio section. Shell on the
other hand has seen some increase in the duration it takes for them to collect on
receivables. This is a “red flag” in the Oil Industry, if the firm is not able to
collect on receivables and has a low accounts receivable turnover then they are
not receiving cash.

56
Inventory Turnover

Inventory Turnover

50.00

40.00 Exxon

30.00 Conoco Phillips

Shell
20.00 BP

10.00 Chevron

0.00
2002 2003 2004 2005 2006

Exxon 20.38 21.26 24.31 30.50 26.29

Conoco Phillips 9.89 8.30 9.16 10.22 7.39
Shell 4.62 5.59 14.52 12.77 11.33
BP 15.31 10.95 9.43 9.50 11.32
Chevron 26.69 33.69 38.30 36.10 32.01
years

This ratio is explained by how fast the companies sell their inventory and
replenish it. It is calculated by taking cost of goods sold and dividing it by
inventory. The higher the number the better off the company is because it
signals that they are able to sell their inventory quickly, and can be viewed that
the company has insufficient inventory which actually could lead to loss of sales,
though that would be a better problem to have then gaining excess inventory
due to not selling your product fast enough. As we can see Chevron has the
highest ratio which means they are selling off their inventory at a much more
rapid pace, and they are still able to keep their inventory well stocked.
Chevron’s inventory has not decreased over the five years to give them this
ratio; it has actually increased by an astounding 69%. To me this forecasts a
battle of giants in the Oil Industry between Chevron and Exxon, and we might

57
see soon in the future Chevron begin to win back some market share. As for the
other three Oil Industries they have a bit more of a problem selling their product
compared to Exxon and Chevron, because they have such a smaller portion of
the market that their refined products sit in their inventory for longer periods of
time. This also flows parallel to the analysis of the other ratios, how the lower
three companies have to increase their accounts receivables to create business.

Days Supply of Inventory

Days Supply of Inventory

100.00

80.00
Exxon

60.00 Conoco Phillips

Shell
40.00 BP
Chevron
20.00

0.00
2002 2003 2004 2005 2006

Exxon 17.91 17.17 15.01 11.97 13.88

Conoco 36.89 43.99 39.85 35.70 49.41
Phillips
Shell 78.99 65.29 25.14 28.57 32.22
BP 23.84 33.32 38.71 38.44 32.25
Chevron 13.68 10.83 9.53 10.11 11.40
years

This is the first portion of the cash merry-go-round, and it is calculated by

365 days divided by inventory turnover. This explains how long inventory
actually doesn’t move to cogs. For Chevron’s merry-go-round they take a full
42.8 days to sell their inventory and then replenish it.
So for instance Shell has significantly reduced their ratio from 2002 to
2006, and in 2006 they turned over their inventory every 32 days. Shell has

58
been the only real volatile company with this ratio. For the most part the whole
industry has been able to keep a steady inventory turnover, which makes sense
because oil is always in demand and there are no seasonal issues.
This is also another ratio where Chevron is the predominate winner and of
course Exxon is close by. They both are able to turnover their inventory at a
consistent flow, and at a rapid pace.

Working Capital Turnover

Working Capital Turnover

100
50
0 Exxon
-50 Conoco Phillips
-100 Shell
-150 BP
-200 Chevron
-250
-300
2002 2003 2004 2005 2006
Exxon 39 31 17 13 14
Conoco -29.80 -37.17 -241.79-104.69 -137.61
Phillips
Shell -21.08 -38.59 37.01 23.73 21.06
BP -144.71 -35.63 -116.45 74.36 -263.85
Chevron -46.83 36.07 15.54 20.77 25.95
years

“This is a measurement comparing the depletion of working capital to the

generation of sales over a given period.”( http://www.answers.com). This is a
good way to find out exactly how well the company is selling its products and
goods to the money being invested in it. As we can see in this industry the ratio

59
is very volatile, and some huge “red flags” are the two companies that are still in
negatives in 2006. The higher the ratio the better off you are, for instance
Chevron in 2006 has a ratio of 25.95 which means for every dollar of working
capital invested there are sales of $25.95.
I honestly think the negative impact on companies in 2002 were still
affected by 9/11/2001. The terrorist attacks led to an oil crisis which in turn
made it harder for companies that were buying or refining oil in those countries
to generate high sales compared to working capital.
In 2006 Shell, Exxon, and Chevron all steadily increased their ratios while
Conoco and especially Bp have declined. This means they have lots of money
tied up into working capital and their sales aren’t covering it.

Conclusion

The liquidity analysis shows Chevron to be a liquid firm with a decent

amount of current assets to cover liabilities. Chevron is on par with the rest of
the industry and in some cases outperforms them.

Profitability Analysis
The Profitability Analysis is used through six ratios that explain how well
the company is able to turn a profit. Very important when dealing with the Oil
Industry since there is lots of money wrapped up in the industry.

60
Gross Profit Margin

Gross Profit Margin

0.30

0.25
Exxon
0.20 Conoco Phillips
0.15 Shell

0.10 BP
Chevron
0.05

0.00
2002 2003 2004 2005 2006
Exxon 0.18 0.20 0.21 0.21 0.23
Conoco 0.13 0.15 0.16 0.17 0.21
Phillips
Shell 0.17 0.17 0.16 0.18 0.18
BP 0.13 0.24 0.25 0.23 0.22
Chevron 0.25 0.25 0.24 0.23 0.27
years

The Gross Profit Margin is computed by sales minus cogs divided by sales.
This ratio helps us understand the use we get from sales after cogs is taken out.
A higher ratio is favored because it means that there is more money left over
after cogs is subtracted. For instance a company with .9 ratios would be very
well off because only 10% is taken out for cogs. As we can see for the Oil
Industry though there is a lot more money in cost of goods sold, this is due to
the fact that refining oil is not cheap and that’s not even mentioning the
shipping, packaging, and delivering. For the most part though these companies
have kept in pace with each other averaging around .15 to .25. This Interpreted
as being these companies all use the same type of methods for refining.

61
Operating Profit Margin

Operating Profit Margin

0.20

0.15 Exxon
Conoco Phillips
0.10 Shell
BP
0.05 Chevron

0.00
2002 2003 2004 2005 2006
Exxon 0.09 0.13 0.14 0.17 0.18
Conoco 0.04 0.08 0.11 0.13 0.15
Phillips
Shell 0.06 0.06 0.07 0.09 0.08
BP 0.07 0.11 0.13 0.13 0.13
Chevron 0.04 0.11 0.14 0.13 0.16
years

A higher Operating Profit Margin is a good signal that the firm is able to
capitalize off of its revenues compared to sales. The higher the ratio the better
the firm is, and it is represented through the firm being able to keep operating
expenses low and revenues high. In the Oil Industry these firms seem to
accomplish just that, they keep their revenues high and to good use while
keeping operating expenses under control enough to where they did not inflate
with revenues. The firms seem to have found a way to keep revenues increasing
faster then their operating expenses, which relates to the fact that oil has a high
demand.

62
Net Profit Margin

Net Profit Margin

0.12
0.10
Exxon
0.08
Conoco Phillips
0.06
Shell
0.04
BP
0.02
Chevron
0.00
-0.02
2002 2003 2004 2005 2006
Exxon 0.06 0.09 0.09 0.10 0.11
Conoco -0.01 0.05 0.06 0.07 0.08
Phillips
Shell 0.06 0.06 0.07 0.09 0.08
BP 0.05 0.08 0.09 0.08 0.08
Chevron 0.01 0.06 0.09 0.07 0.08
years

This ratio is a pretty key ratio when being compared to competitors. It

shows how much the company is actually holding for earnings compared to
sales. The higher the number the better off the company is perceived to be
doing. Amazingly Chevron, Conoco, Shell, and BP all ended 2006 with about the
same ratio of .08, while Exxon is on top of the pack with .11. This is very
interesting because it seems that in this industry all of the firms rose consistently
together.

63
Asset Turnover

Asset Turnover

2.00

1.50 Exxon
Conoco Phillips
1.00 Shell
BP
0.50 Chevron

0.00
2002 2003 2004 2005 2006
Exxon 1.32 1.36 1.49 1.72 1.67
Conoco 0.74 1.27 1.47 1.71 1.14
Phillips
Shell 1.05 1.15 1.42 1.40 1.36
BP 1.12 0.97 1.01 1.18 1.26
Chevron 1.27 1.47 1.62 1.54 1.54
years

The asset turnover is computed by sales divided by total assets, and it is

key to find out how much sales is actually collected compared to its total assets.
The higher the ratio the more successful the company is. We finally can see
some diversity in the company’s ratios, and lets take a look at Conoco’s decline
from 2005 to 2006. It seems that Conoco has actually increased its total assets
compared to sales, and this goes along with some of our other ratios dealing
with A/R’s. Since Conoco has increased their A/R over the years it has a
negative effect on their asset turnover ratio. As for the other companies they
seem to all fall around the same points and patterns.
This ratio can also be compared to profits, and if a company has a high
profit margin which means a high net income to sales, then they have a low
asset turnover since their sales are somewhat small.

64
Return on Assets

Return on Assets

0.20

0.15
Exxon

0.10 Conoco Phillips

Shell
0.05 BP
Chevron
0.00

-0.05
2002 2003 2004 2005 2006
Exxon 0.08 0.14 0.15 0.19 0.19
Conoco -0.01 0.06 0.10 0.15 0.15
Phillips
Shell 0.07 0.08 0.11 0.14 0.12
BP 0.06 0.08 0.10 0.10 0.10
Chevron 0.02 0.09 0.16 0.15 0.14
years

Calculating Return on Assets is interesting because you use the current

year net income and divide by the previous year total assets to achieve a
percentage of total assets to net income. The higher the percentage the better
the company is earning profits over its total assets. This is very important in the
Oil Industry because of the amount of investment in long term assets the
companies have to make. As you can see it pays off over the 5 years for all of
the firms, because after a certain extent of time the investments on the long
term assets end up earning more profits for the company compared to the
depreciation expenses. The firms seem to run together as far as increasing their
percentages, but Exxon seems to be in a league of there own again. For the rest
of the companies they seem to flock very closely together, insinuating that these
firms seem to have the same type of assets involved in their operations.

65
Return on Equity

Return on Equity

0.40
0.35
0.30 Exxon
0.25 Conoco Phillips
0.20
Shell
0.15
0.10 BP
0.05 Chevron
0.00
-0.05
2002 2003 2004 2005 2006
Exxon 0.15 0.24 0.25 0.32 0.35
Conoco -0.01 0.14 0.19 0.26 0.19
Phillips
Shell 0.12 0.14 0.21 0.27 0.23
BP 0.12 0.19 0.22 0.25 0.25
Chevron 0.04 0.20 0.29 0.22 0.25
years

Return on Equity is calculated based off of the same basis as ROA, you
take Net income from the current year divided by Equity from the previous year.
This ratio shows us that for every dollar of equity there is a certain amount of
net income. For example, in 2006 Chevron only had a quarter of net income for
every dollar of equity, which means these oil companies have a high amount of
equity mainly from there assets. The trend in these ratios compared to the
competitors seems to be very well correlated to each other, and once again
proving that the Oil industry as a whole is very closely constructed to each other
in terms of earning profits.

66
Capital Structure Analysis
These ratios give an important look at the financing side of the company
and how it finances its assets. They give a definitive look at the credit risk of the
firm and whether the company can focus on increasing value or paying down
debt.

Debt to equity ratio

Debt to equity ratio

2.00

1.50 Exxon
Conoco Phillips
1.00 Shell
BP
0.50 Chevron

0.00
2002 2003 2004 2005 2006
Exxon 1.05 0.94 0.92 0.87 0.92
Conoco 1.60 1.40 1.17 1.03 0.99
Phillips
Shell 0.79 0.74 1.05 1.24 1.05
BP 1.29 1.49 1.53 1.60 1.57
Chevron 1.45 1.24 1.06 1.01 0.92
years

The debt to equity ratio calculates the total liabilities divided by owner’s
equity, and gives the reader an idea of how much debt there is for every dollar
of owner’s equity. There must be a significant amount of assets to pay off debt
or the company is on the road to bankruptcy. The lower the ratio the better the
performance the company has. This is an important ratio to view in comparison

67
with competitors to get a perspective on which firms have a high amount of debt
to try and finance their business. BP seems to have a tall ratio in comparison to
the other firms, and this is because BP is a fairly new competitor to the industry.
Conoco on the other hand has reduced their ratio significantly from 1.6 in 2002
to .99 in 2006. It is very important for the oil companies to keep a low debt to
equity ratio since having to finance your operations outside of your company is
not self sufficient enough to profit in such a volatile industry.

Times interest earned

Times Interest earned

200.00

150.00
Exxon
100.00 Conoco Phillips
50.00 Shell

0.00 BP
Chevron
-50.00

-100.00
2002 2003 2004 2005 2006
Exxon 43.99 154.43 64.64 119.82 103.06
Conoco 3.36 10.28 28.17 43.21 26.81
Phillips
Shell 7.40 9.10 18.41 24.88 22.90
BP -12.79 0.00 0.00 15.72 -58.65
Chevron 7.26 26.74 50.62 52.28 70.90
years

Looking at this ratio we can see that net income before interest and taxes
is divided by interest expense and it helps the reader to analyze how much
money there is to cover interest and taxes to every dollar of interest expense.

68
 The main companies I want to focus on here are BP and Exxon. BP
seems to have a negative amount of income before interest and taxes for every
dollar of interest expense in 2006. This is a huge “red flag” when thinking about
it logically, BP seems to have insufficient funds to actually cover their interest
and taxes and this seems to be an issue with them being able to cover their
debts. This ratio correlates well with our debt to equity ratio since in that ratio
they have a high amount of debt compared to owner’s equity.
As for Exxon, and even somewhat Chevron, they seem to self sustain their
company through internal financing and reducing outsourced debt. This is
promising for investors to know that the company they trust their money with is
able to reduce debt and increase shareholder’s wealth.
Debt Service Margin

Debt Service Margin

10.00

8.00
Exxon

6.00 Conoco Phillips

Shell
4.00 BP
Chevron
2.00

0.00
2002 2003 2004 2005 2006
Exxon 3.20 5.99 8.09 7.74 7.42
Conoco 0.26 0.57 0.83 1.64 0.93
Phillips
Shell 2.31 2.42 3.00 3.97 3.26
BP 1.47 0.82 1.10 1.08 1.09
Chevron 0.93 1.16 1.44 1.70 3.28
years

The debt service margin is calculate the same as ROA and ROE by taking
operating cash flow of the current year and dividing it by last years notes

69
payable. This ratio provides us with how well the company can cover its notes
payable through operating cash flow. Exxon seems to exceed once again in this
field and has found a way to increasingly cover every dollar of notes payable
with $4-$6 of operating cash flow. As for the rest of the companies they seem
to be along the same boundaries of $0-$4.

Conclusion
After calculating and examining the Liquidity ratios, Profitability ratios, and
Capital structure ratios we can better asses the operations and investing
activities of these firms. Better yet we were able to compare all of these ratios
with each competitor to actually give a benchmark for each and every analysis.

70
Internal Growth Rate
The internal growth rate (IGR) is the maximum growth of a firm can
achieve relying simply on their internal cash flows, with no outside funding.
Internal growth rate is a calculation found by multiplying the return on equity by
the difference of 1 and the dividend payout ratio. Chevron holds an advantage
over the rest of the industry with an average 3.51% higher IGR, meaning that
the firm is capable of realizing the greater growth than its competitors if it were
forced to operate on currently owned assets alone. This is not the case for each
year. For example, in 2006, Chevron’s internal growth rate was slightly lower
than the industry average. The firm’s IGR has reached higher levels in recent
years, which bodes well for its ability to sustain on its own in the even that
outside financing is in a crunch and subsequently difficult to obtain.

Internal Growth Rate

0.25

0.20
Chevron
0.15 BP
ExxonMobil
0.10 ConocoPhillips
Industry Average
0.05

0.00
2002 2003 2004 2005 2006
Chevron 0.24 0.13 0.20 0.19 0.17
BP 0.09 0.12 0.13 0.14 0.14
ExxonMobil 0.12 0.18 0.19 0.22 0.23
ConocoPhillips 0.01 0.08 0.11 0.16 0.17
Industry Average 0.12 0.13 0.16 0.18 0.18

71
Sustainable Growth Rate
The sustainable growth rate (SGR) is a measure of a firm’s maximum
possible growth if no additions are made to its current financial leverage. If the
firm were to surpass its SGR, it would be forced to borrow additional funds to
maintain growth. The rate of sustained growth is found by taking the IGR
calculation for the firm and multiplying it by the sum of 1 and the firm’s debt-to-
equity ratio. When comparing SGR and IGR, we are able to see that the
difference between the two each year grows smaller as we move from the past
toward the present. This tells us that Chevron’s potential growth depends much
less on outside financing in recent years than it has in the past. Competitors in
the market seem to rely more on outside financing for their company growth
than Chevron does, and therefore those firms might be seen as less stable.

Sustainable Growth Rate

0.50

0.40
Chevron
0.30 BP
ExxonMobil
0.20 ConocoPhillips
Industry Average
0.10

0.00
2002 2003 2004 2005 2006
Chevron 0.36 0.18 0.25 0.23 0.20
BP 0.22 0.29 0.34 0.37 0.36
ExxonMobil 0.25 0.36 0.36 0.42 0.44
ConocoPhillips 0.03 0.18 0.25 0.33 0.33
Industry Average 0.21 0.25 0.30 0.34 0.33

72
Financial Statement Forecasting

Forecasting is one of the most important aspects of analyzing a company

and is pivotal in how the market reacts to a company. Past performance and the
direction of the industry are keys to assessing where a company should be. The
financial statements give the best look inside the company and hopefully its most
up to date and reliable figures. Looking at Chevron and its competitor’s 10-K
reports gives us the best inclination of what to expect in the next ten years.
Obviously, short-range forecasts are the most reliable and become less so as we
move toward the 10 year mark. Knowing this, we forecasted Chevron’s income
statement, balance sheet, and statement of cash flows through the remainder of
2007 to 2016. Each statement is unique in the method used to forecast it. The
income statement is based mostly off of past growth rates and industry
averages. While the balance sheet mixes growth rates with liquidity ratios. The
statement of cash flows requires a different set of ratios that are more difficult
and less reliable. Hopefully, these numbers can somewhat reflect where the firm
will be heading in the near future but this is rarely the case. It would be
unreasonable to assume a company would not have a down year and continue to
grow at the same rate but it sets a good benchmark based on reason and
historical evidence.

Income Statement
The forecasting of the income statement is simple in its process, but very
important that the correct growth rate is selected. Each line item is first shown
as a percentage of net sales. Some of these lines showed a clear and gradual
increase while others showed no semblance of structure. There are a great deal
of variables that can affect the direction of these percentages such as a
significant market event or the acquisition of a company. In Chevron’s case, the
acquisition of Unocal in 2005 and the surge in the price of oil have a large impact
of net revenues, operating expenses, and the purchasing of crude oil products.

73
To get a broad understanding of the direction each line item is heading, we took
the average of all six years and an average of 2004 through 2006. The numbers
seem to climb up from 2004 to a smaller plateau in 2005 and 2006. Averaging in
the first three years could be deceiving in some cases. These are obvious when
the full average is quite different from the three year. An industry average was
calculated for important line items but there is too large of a discrepancy
between the sizes and scopes of the top six firms in the industry. ConocoPhillips
and BP seemed to match the best with Chevron’s averages due to their similar
size and scope of operations.
Each line item showed some form of direction, thus each one was
forecasted out. Sales growth was also calculated in order to forecast total
revenue since it would not be divided by itself. Sales Growth tends to revert to
its mean over time excluding outliers. This made sales growth a good
foundation to base the rest of the forecasts off of. Total revenue and net
income are the two most important forecasts on the income statement as they
are used in a number of other calculations, especially the balance sheet. Sales
growth was determined to be 8% because the industry is so volatile. Chevron’s
sales growth had fluctuated between losing 7% and gaining close to 30%. The
tragedy of September 11, 2001 and an economic downturn led to dismal sales in
2002 and the surge in the price and return to historical demands of gas
afterward led to a surge in sales for the industry. No industry can keep up a
30% growth rate and that is seen in 2006 as sales growth returns to a normal
6%. Looking at the industry averages and return to more reasonable growth
rates, a rate of 8% should fare well through rise and fall.
The rest of the forecasts were much more consistent and true to form.
Net income tends to follow sales and rightfully it grows at 8% as well. These
predicted values are an optimistic view into the future. There are any number of
factors that can take it off course which is why the closer projections are the
least risky. The key is to select the rate that is best perceived over time and the
numbers should come relatively close.

74
ANNUAL INCOME STATEMENT Actual Financial Statements Forecast Financial Statements
Avg. 04-
2001 2002 2003 2004 2005 2006 Average 06 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

(in millions)

TOTAL REVENUES & OTHER INCOME 106,245 98,913 121,761 153447 198,200 210,118 15.48% 20.40% 8.00% 226,927 245,082 264,688 285,863 308,732 333,431 360,105 388,914 420,027 453,629

COST OF GOODS SOLD 77,541 74,306 91,397 116,819 153,309 154,260 75.01% 75.63% 75.00% 170,196 183,811 198,516 214,397 231,549 250,073 270,079 291,685 315,020 340,222

GROSS PROFIT 28,704 24,607 30,364 36,628 44,891 55,858 24.99% 24.37% 25.00% 56,732 61,270 66,172 71,466 77,183 83,358 90,026 97,228 105,007 113,407

Purchased Crude Oil Products 60,549 57,249 71,583 94,419 127,968 128,151 60.12% 62.36% 61.00% 138,426 149,500 161,460 174,377 188,327 203,393 219,664 237,237 256,216 276,714

Operating Expenses 7,650 7,848 8,553 9,832 12,191 14,624 6.95% 6.51% 7.00% 15,885 17,156 18,528 20,010 21,611 23,340 25,207 27,224 29,402 31,754
Selling, General & Administrative
Expenses 3,984 4,155 4,440 4,557 4,828 5,093 3.24% 2.61% 3.00% 6,808 7,352 7,941 8,576 9,262 10,003 10,803 11,667 12,601 13,609

TOTAL COSTS AND EXPENSES 36,391 32,385 108,990 134,749 173,003 178,142 69.40% 86.63% 88.00% 199,696 215,672 232,926 251,560 271,684 293,419 316,893 342,244 369,624 399,194
OPERATING INCOME 8,291 4,100 12,676 20,551 25,197 31,976 10.61% 13.77% 13.00% 29,501 31,861 34,409 37,162 40,135 43,346 46,814 50,559 54,603 58,972

INCOME TAX EXPENSE 4,360 2,998 5,294 7,517 11,098 14,838 4.84% 5.85% 6.00% 13,616 14,705 15,881 17,152 18,524 20,006 21,606 23,335 25,202 27,218

NET INCOME (LOSS) 3,288 1,132 7,230 13,328 14,099 17,138 5.69% 7.99% 7.00% 15,885 17,156 18,528 20,010 21,611 23,340 25,207 27,224 29,402 31,754

COMMON SIZE INCOME STATEMENT Actual Financial Statements Forecast Financial Statements
Avg. 04-
2001 2002 2003 2004 2005 2006 Average 06 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

SALES GROWTH -6.90% 23.10% 26.02% 29.17% 6.01% 15.48% 20.40% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%

TOTAL REVENUES & OTHER INCOME 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

COST OF GOODS SOLD 72.98% 75.12% 75.06% 76.13% 77.35% 73.42% 75.01% 75.63% 75% 75% 75% 75% 75% 75% 75% 75% 75% 75% 75%

GROSS PROFIT 27.02% 24.88% 24.94% 23.87% 22.65% 26.58% 24.99% 24.37% 25% 25% 25% 25% 25% 25% 25% 25% 25% 25% 25%

Purchased Crude Oil Products 56.99% 57.88% 58.79% 61.53% 64.57% 60.99% 60.12% 62.36% 61% 61% 61% 61% 61% 61% 61% 61% 61% 61% 61%

Operating Expenses 7.20% 7.93% 7.02% 6.41% 6.15% 6.96% 6.95% 6.51% 7% 7% 7% 7% 7% 7% 7% 7% 7% 7% 7%
Selling, General & Administrative
Expenses 3.75% 4.20% 3.65% 2.97% 2.44% 2.42% 3.24% 2.61% 3% 3% 3% 3% 3% 3% 3% 3% 3% 3% 3%

TOTAL COSTS AND EXPENSES 34.25% 32.74% 89.51% 87.81% 87.29% 84.78% 69.40% 86.63% 88% 88% 88% 88% 88% 88% 88% 88% 88% 88% 88%

OPERATING INCOME 7.80% 4.15% 10.41% 13.39% 12.71% 15.22% 10.61% 13.77% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%

INCOME TAX EXPENSE 4.10% 3.03% 4.35% 4.90% 5.60% 7.06% 4.84% 5.85% 6% 6% 6% 6% 6% 6% 6% 6% 6% 6% 6%

NET INCOME (LOSS) 3.09% 1.14% 5.94% 8.69% 7.11% 8.16% 5.69% 7.99% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00%

75
Balance Sheet
The balance sheet uses the same idea as the income statement by
dividing each line item by its main channel. Each asset is a percentage of total
assets and each liability or stockholder’s equity is a percentage of its namesake’s
total. The same six year and three year averages were applied to find any rates
that could be forecasted. The big difference with the balance sheet is the use of
liquidity ratios to find inventories, total assets, and total current liabilities.
The asset portion of the balance sheet began with total assets. Total
assets grow with sales from the income statement. Thus, we can find total
assets by increasing it relative to our growth in sales. We used inventory
turnover to find inventories and the current ratio to find total current liabilities.
Having total assets, current and non-current asset should sum up to equal the
total. This was easily seen in the averages as current assets represented 26.5%
and non-current with the other 73.5% of total assets.
The stockholder’s equity section is a very important section. We first look
at our forecasts of net income and dividends in order to calculate retained
earnings. The equation takes the beginning balance of retained earnings from
the previous year, adding forecasted net income and subtracting forecasted
dividends to arrive at the ending balance of retained earnings. From this point,
shareholder’s equity must reflect the change in retained earnings making it a
simple computation. Total liabilities are simply the total assets minus our
computed shareholder’s equity. Other line items for liabilities were found using
the common sized statement figures.
Other line items were treated the same as was performed on the income
statement. The balance sheet gives a much clearer picture of how we can use
the income statement and other financial formulas to arrive at the best forecast.

76
Balance Sheet Actual Financial Statements Forecast Financial Statements

2001 2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Assets

Current Assets:
Cash and cash equivalents $2,117 $2,957 $4,266 $9,291 $10,043 $10,493 7.50% $11,189 $11,916 $12,691 $13,515 $14,394 $15,330 $16,326 $17,387 $18,517 $19,721

Marketable securities $1,033 $824 $1,001 $1,451 $1,101 $953

Accounts and notes receivable $8,279 $9,385 $9,722 $12,429 $17,184 $17,628 13% $19,394 $20,654 $21,997 $23,427 $24,950 $26,571 $28,298 $30,138 $32,097 $34,183
Inventories $2,948 $2,763 $2,648 $2,983 $4,121 $4,656 ITO=33 $5,157 $5,570 $6,016 $6,497 $7,017 $7,578 $8,184 $8,839 $9,546 $10,310

Prepaid expenses and other current Assets $1,769 $1,847 $1,789 $2,349 $1,887 $2,574
Total Current Assets $16,146 $17,776 $19,426 $28,503 $34,336 $36,304 26.50% $39,049 $42,173 $45,547 $49,191 $53,126 $57,376 $61,966 $66,924 $72,277 $78,060
Long Term Receivables $1,225 $1,338 $1,493 $1,419 $1,686 $2,203 1.50% $2,238 $2,383 $2,538 $2,703 $2,879 $3,066 $3,265 $3,477 $3,703 $3,944

Investments and advances $12,252 $11,097 $12,319 $14,389 $17,057 $18,552

Deferred Charges $2,886 $2,993 $3,694 $4,439 $4,428 $2,088

Properties, Plant, and Equipment, Net (at cost) $42,882 $44,155 $44,538 $44,458 $63,690 $68,858 52% $77,576 $82,618 $87,988 $93,707 $99,798 $106,285 $113,194 $120,551 $128,387 $136,732

Goodwill $0 $0 $0 $0 $4,636 $4,623

Total Non-Current Assets $59,245 $59,583 $62,044 $64,705 $91,497 $96,324 73.50% $109,650 $116,777 $124,368 $132,452 $141,061 $150,230 $159,995 $170,395 $181,470 $193,266
Total Assets $75,391 $77,359 $81,470 $93,208 $125,833 $132,628 $149,437 $167,591 $187,198 $208,373 $231,242 $255,941 $282,615 $311,423 $342,536 $376,138

Liabilities

Current Liabilities: $147,355 $159,144 $171,875 $185,625 $200,476 $216,514 $233,835 $252,541 $272,745 $294,564
Accounts Payable $6,427 $8,455 $8,675 $10,747 $16,074 $16,675 25% $14,967 $19,499 $20,324 $21,155 $21,990 $22,824 $23,649 $24,461 $25,250 $26,010

Short-term debt $8,429 $5,358 $1,703 $816 $739 $2,159

Accrued liabilities $3,399 $3,364 $3,172 $3,410 $3,690 $4,546

Federal and other taxes on income $1,398 $1,626 $1,392 $2,502 $3,127 $3,626

Other taxes payable $1,001 $1,073 $1,169 $1,320 $1,381 $1,403

Total Current Liabilities $20,654 $19,876 $16,111 $18,795 $25,011 $28,409 CR=1.35 $28,925 $31,239 $33,738 $36,438 $39,353 $42,501 $45,901 $49,573 $53,539 $57,822

Long-term debt $8,704 $10,666 $10,651 $10,217 $11,807 $7,405

Capital Lease Obligations $285 $245 $243 $239 $324 $274

Deferred credits and other noncurrent obligations $4,394 $4,474 $7,758 $7,942 $10,507 $11,000

Noncurrent deferred income taxes $6,132 $5,619 $6,417 $7,266 $11,262 $11,647
Reserves for employee benefit plans $3,162 $4,572 $3,727 $3,345 $4,046 $4,749 7.25% $5,419 $5,655 $5,894 $6,135 $6,377 $6,619 $6,858 $7,094 $7,323 $7,543

Minority interest $283 $303 $268 $172 $200 $209

Total Non-Current Liabilities $22,960 $25,879 $29,064 $29,181 $38,146 $35,284 58% $34,724 $45,238 $47,151 $49,080 $51,016 $52,951 $54,865 $56,748 $58,581 $60,343

Total Liabilities $43,614 $45,755 $45,175 $47,976 $63,157 $63,693 $59,869 $77,996 $81,295 $84,621 $87,959 $91,294 $94,594 $97,842 $101,001 $104,040

Shareholders' Equity

77
Preferred Stock $0 $0 $0 $0 $0 $0

Common Stock $853 $853 $1,706 $1,706 $1,832 $1,832

Capital Surplus $4,811 $4,833 $4,002 $4,160 $13,894 $14,126

Retained Earnings $32,767 $30,942 $35,315 $45,414 $55,738 $68,464 $89,097 $111,380 $135,446 $161,437 $189,507 $219,823 $252,565 $287,925 $326,115 $367,359

Accumulated Other Comprehensive Income ($306) ($998) ($809) ($319) ($429) ($2,636)

Deferred compensation and benefit plan trust ($752) ($654) ($602) ($607) ($486) ($454)

Treasury Stock ($3,415) ($3,374) ($3,317) ($5,124) ($7,870) ($12,395)

Total Shareholders Equity $33,958 $31,604 $36,295 $45,230 $62,676 $68,935 $89,568 $111,851 $135,917 $161,908 $189,978 $220,294 $253,035 $288,396 $326,586 $367,831

Total Liabilities and Shareholders Equity $77,572 $77,359 $81,470 $93,208 $125,883 $132,628 $149,437 $167,591 $187,198 $208,373 $231,242 $255,940 $282,615 $311,423 $342,536 $376,139

78
Common Size Balance Sheet Actual Financial Statements
Average
2001 2002 2003 2004 2005 2006 Average 04-06 Assume

Assets

Current Assets:
Cash and cash equivalents 2.81% 3.82% 5.24% 9.97% 7.98% 7.91% 6.29% 8.62% 7.50%

Marketable securities 1.37% 1.07% 1.23% 1.56% 0.87% 0.72% 1.14% 1.05%
Accounts and notes receivable 10.98% 12.13% 11.93% 13.33% 13.66% 13.29% 12.55% 13.43% 13.00%
Inventories 3.91% 3.57% 3.25% 3.20% 3.27% 3.51% 3.45% 3.33% 3.50%
Prepaid expenses and other current
Assets 2.35% 2.39% 2.20% 2.52% 1.50% 1.94% 2.15% 1.99%
Total Current Assets 21.42% 22.98% 23.84% 30.58% 27.29% 27.37% 25.58% 28.41% 26.50%
Long Term Receivables 1.62% 1.73% 1.83% 1.52% 1.34% 1.66% 1.62% 1.51% 1.50%

Investments and advances 16.25% 14.34% 15.12% 15.44% 13.56% 13.99% 14.78% 14.33%

Deferred Charges 3.83% 3.87% 4.53% 4.76% 3.52% 1.57% 3.68% 3.29%
Properties, Plant, and Equipment, Net (at
cost) 56.88% 57.08% 54.67% 47.70% 50.61% 51.92% 53.14% 50.08% 52.00%

Goodwill 0.00% 0.00% 0.00% 0.00% 3.68% 3.49% 1.19% 2.39%

Total Non-Current Assets 78.58% 77.02% 76.16% 69.42% 72.71% 72.63% 74.42% 71.59% 73.50%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% ATO=1.54

Liabilities

Current Liabilities:
Accounts Payable 14.74% 18.48% 19.20% 22.40% 25.45% 26.18% 21.07% 24.68% 25.00%

Short-term debt 19.33% 11.71% 3.77% 1.70% 1.17% 3.39% 6.84% 2.09%

Accrued liabilities 7.79% 7.35% 7.02% 7.11% 5.84% 7.14% 7.04% 6.70%

Federal and other taxes on income 3.21% 3.55% 3.08% 5.22% 4.95% 5.69% 4.28% 5.29%

Other taxes payable 2.30% 2.35% 2.59% 2.75% 2.19% 2.20% 2.39% 2.38%
Total Current Liabilities 47.36% 43.44% 35.66% 39.18% 39.60% 44.60% 41.64% 41.13% 42.00%

Long-term debt 19.96% 23.31% 23.58% 21.30% 18.69% 11.63% 19.74% 17.21%

Capital Lease Obligations 0.65% 0.54% 0.54% 0.50% 0.51% 0.43% 0.53% 0.48%
Deferred credits and noncurrent
obligations 10.07% 9.78% 17.17% 16.55% 16.64% 17.27% 14.58% 16.82%

Noncurrent deferred income taxes 14.06% 12.28% 14.20% 15.15% 17.83% 18.29% 15.30% 17.09%
Reserves for employee benefit plans 7.25% 9.99% 8.25% 6.97% 6.41% 7.46% 7.72% 6.94% 7.25%

Minority interest 0.65% 0.66% 0.59% 0.36% 0.32% 0.33% 0.48% 0.33%
Total Non-Current Liabilities 52.64% 56.56% 64.34% 60.82% 60.40% 55.40% 58.36% 58.87% 58.00%

Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Shareholders' Equity

Preferred Stock 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Common Stock 2.51% 2.70% 4.70% 3.77% 2.92% 2.66% 3.21% 3.12%

Capital Surplus 14.17% 15.29% 11.03% 9.20% 22.17% 20.49% 15.39% 17.29%
Retained Earnings 96.49% 97.91% 97.30% 100.41% 88.93% 99.32% 96.73% 96.22% 95.50%
Accumulated Other Comprehensive
Income -0.90% -3.16% -2.23% -0.71% -0.68% -3.82% -1.92% -1.74%
Deferred compensation and benefit plan
trust -2.21% -2.07% -1.66% -1.34% -0.78% -0.66% -1.45% -0.93%

Treasury Stock -10.06% -10.68% -9.14% -11.33% -12.56% -17.98% -11.96% -13.96%
Total Shareholders Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% ROE=25%

79
Statement of Cash Flows
The statement of cash flows was also common sized in order to find any
items to be forecasted. This is rarely the case with this statement as there is
rarely any consistency over a number of years with cash flows. Net Income is
the item to be reconciled and we have already forecasted it for these years but it
can be useful to have there. The process to find the best growth rate for cash
flows from operations is to manipulate CFFO/Sales, CFFO/OI, and CFFO/NI. The
only one that showed any correlation to the statement was CFFO/NI. Using this
ratio, we found CFFO to be 140% of net income on average. By multiplying
CFFO by this percentage gave us a steadily increasing and manageable CFFO.
CFFI on the other hand is a function of its heaviest factor which is capital
expenditures. Over time this rate has increased by 6%, so it would seem that
the cash flow from investing would follow its largest contributor. Lastly, we
subtracted the free cash flow from investing activities from the free cash flow
from operating activities to arrive at our free cash flows to the firm.

Conclusion
Overall, Chevron has been consistent in following the other enormous oil
companies and continues to grow in stride. New acquisitions continue to expand
the company and the increasing price of oil will only provide more fuel to the
fire. Chevron continues to pay off debt and increase its capital and that is a key
to success in this industry.

80
81
Statement of Cash Flows Actual Financial Statements Forecast Financial Statements

2002 2003 2004 2005 2006 Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Cash Flows from Operating Activities

Net Income $1,132 $7,230 $13,328 $14,099 $17,138 $15,885 $17,156 $18,528 $20,010 $21,611 $23,340 $25,207 $27,224 $29,402 $31,754

Adjustments

Depreciation, depletion and amortization $5,169 $5,326 $4,935 $5,913 $7,506

Dry hole expense $288 $256 $286 $226 $520

Distributions less than income from equity affiliates $510 -$383 -$1,422 -$1,304 -$979

Net before-tax gains on asset retirements and sales -$33 -$194 -$1,882 -$134 -$229

Net foreign currency effects $5 $199 $60 $62 $259

Deferred income tax provision -$81 $164 -$224 $1,393 $614

Net decrease (increase) in operating working capital $1,125 $162 $430 -$54 $1,044

Minority interest in net income $57 $80 $85 $96 $70

Increase in long-term receivables -$39 $12 -$60 -$191 -$900

Decrease (increase) in other deferred charges $428 $1,646 -$69 $668 $232

Cumulative effect of changes in accounting principles $196

Write-down of investments in Dynegy, before tax $1,796

Gain from Dynergy, before tax -$365

Cash contributions to employee pension plans -$246 -$1,417 -$1,643 -$1,022 -$449

Other -$168 -$597 $866 $353 -$503

Net Cash Provided By Operating Activities $9,943 $12,315 $14,690 $20,105 $24,323 $25,416 $28,402 $31,704 $35,352 $39,381 $43,828 $48,734 $54,145 $60,111 $66,683

Cash Flows from Investing Activities

Cash Portion of Unocal acquisition, net of Unocal cash
received -$5,934

Capital Expenditures -$7,597 -$5,625 -$6,310 -$8,701 -$13,813

Repayment of loans by equity affiliates $293 $1,790 $57 $463

Proceeds from asset sales $2,341 $1,107 $3,671 $2,681 $989

Net sales (purchases) of marketable securities $209 $153 -$450 $336 $142

Advances to equity affiliate -$2,200

- - - - - - - - - -
Net Cash Used For Investing Activities -$3,499 -$4,072 -$3,499 -$11,561 -$12,219 6% $12,952 $13,729 $14,553 $15,426 $16,352 $17,333 $18,373 $19,475 $20,644 $21,882

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Cash Flows from Financing Activities

Net (payments) borrowings of short-term obligations -$1,810 -$3,628 $114 -$109 -$677
Repayments of long-term debt and other financing
obligations -$1,356 -$1,347 -$1,398 -$966 -$2,224
Cash dividends - common stock -$2,965 -$3,033 -$3,236 -$3,778 -$4,396 8% -$4,748 -$5,127 -$5,538 -$5,981 -$6,459 -$6,976 -$7,534 -$8,137 -$8,788 -$9,491

Dividends paid to minority interests -$26 -$37 -$41 -$98 -$60

Net purchases of treasury shares $41 $57 -$1,645 -$2,597 -$4,491

Redemption of preferred stock of subsidiaries -$75 -$18 -$140

Proceeds from issuances of long-term debt $2,045 $1,034 $20

Net Cash Used For Financing Activities -$4,071 -$7,029 -$6,224 -$7,668 -$11,848

Free Cash Flows $13,442 $16,387 $18,189 $31,666 $36,542 $12,464 $14,673 $17,151 $19,926 $23,029 $26,495 $30,361 $34,670 $39,467 $44,801

Effect of Exchange Rate Changes on Cash & Cash

Equivalents $15 $95 $58 -$124 $194

Net Changes in Cash and Cash Equivalents $840 $1,309 $5,025 $752 $450

Cash and Cash Equivalents at January 1 $2,117 $2,957 $4,266 $9,291 $10,043

Cash and Cash Equivalents at December 31 $2,957 $4,266 $9,291 $10,043 $10,493

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Common Size Cash Flow Statement Actual Financial Statements

2002 2003 2004 2005 2006 Average Avg. 04-06 Assume

Cash Flows from Operating Activities

Net Income 11.38% 58.71% 90.73% 70.13% 70.46% 60.28% 77.11% 65.00%

Adjustments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Depreciation, depletion and amortization 51.99% 43.25% 33.59% 29.41% 30.86% 37.82% 31.29% 33.00%

Dry hole expense 2.90% 2.08% 1.95% 1.12% 2.14% 2.04% 1.74%

Distributions less than income from equity affiliates 5.13% -3.11% -9.68% -6.49% -4.02% -3.63% -6.73%

Net before-tax gains on asset retirements and sales -0.33% -1.58% -12.81% -0.67% -0.94% -3.27% -4.81%

Net foreign currency effects 0.05% 1.62% 0.41% 0.31% 1.06% 0.69% 0.59%

Deferred income tax provision -0.81% 1.33% -1.52% 6.93% 2.52% 1.69% 2.64%

Net decrease (increase) in operating working captial 11.31% 1.32% 2.93% -0.27% 4.29% 3.92% 2.32%

Minority interest in net income 0.57% 0.65% 0.58% 0.48% 0.29% 0.51% 0.45%

Increase in long-term receivables -0.39% 0.10% -0.41% -0.95% -3.70% -1.07% -1.69%

Decrease (increase) in other deferred charges 4.30% 13.37% -0.47% 3.32% 0.95% 4.30% 1.27%

Cumulative effect of changes in accounting principles 0.00% 1.59% 0.80%

Write-down of investments in Dynegy, before tax 18.06% 18.06%

Gain from Dynergy, before tax 0.00% -2.96% -1.48%

Cash contributinos to employee pension plans -2.47% -11.51% -11.18% -5.08% -1.85% -6.42% -6.04%

Other -1.69% -4.85% 5.90% 1.76% -2.07% -0.19% 1.86%

Net Cash Provided By Operating Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cash Flows from Investing Activities

Cash Portion of Unocal acquisition, net of Unocal cash received 51.33% 51.33% 51.33%

Capital Expenditures 217.12% 138.14% 180.34% 75.26% 113.05% 144.78% 122.88%

Repayment of loans by equity affiliates -7.20% -51.16% -0.49% -3.79% -15.66% -18.48%

Proceeds from asset sales -66.90% -27.19% -104.92% -23.19% -8.09% -46.06% -45.40%

Net sales (purchases) of marketable securities -5.97% -3.76% 12.86% -2.91% -1.16% -0.19% 2.93%

Advances to equity affiliate 62.88% 62.88% 62.88%

Net Cash Used For Investing Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cash Flows from Financing Activities

Net (payments) borrowings of short-term obligations 44.46% 51.61% -1.83% 1.42% 5.71% 20.28% 1.77%

Repayments of long-term debt and other financing obligations 33.31% 19.16% 22.46% 12.60% 18.77% 21.26% 17.94%

Cash dividends - common stock 72.83% 43.15% 51.99% 49.27% 37.10% 50.87% 46.12%

Dividends paid to minority interests 0.64% 0.53% 0.66% 1.28% 0.51% 0.72% 0.81%

Net purchases of treasury shares -1.01% -0.81% 26.43% 33.87% 37.91% 19.28% 32.73%

Redemption of preferred stock of subsidiaries 1.07% 0.29% 1.83% 1.06% 1.06%

Proceeds from issuances of long-term debt -50.23% -14.71% -0.26% -21.73% -0.26%

Net Cash Used For Financing Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

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 Analysis of Valuations

There are two basic methods to find the price per share of a company.
Method of comparables is a market based valuation that takes what the market
says and turns that into different per share prices. It uses the industry average
to draw an immediate conclusion to the firm’s value. Intrinsic valuations use our
forecasted numbers to derive different per share prices with different inputs.
This is much more reliable as we have a better view of the firm and can make
adjustments to find the best value. Overall, these valuations give out what you
put into them. The more reliable methods are valued higher to give us the best
view of what the value of the firm is.

Method of Comparables
In using the method of comparables, we are able to value a company
based on industry averages and compute its share price. We used Chevron’s
financial data as well as its competitors to determine these ratios. Providing
toward the industry ratio includes our following competitors: Exxon/Mobil,
Conoco/Philips, and BP. We used the industry average to compute each price
per share and used information from yahoo finance. The following is a
breakdown of each ratio.

Forward Price to Earnings

We used our forecasted earnings per share and our current price as stated
by Chevron and we computed a P/E ratio for the company. We did the same for
our competitors with the help of yahoo finance. We then took the average of
the four companies to determine an industry average. After calculating an
industry average of 10.17, we then multiplied this by Chevrons EPS of 8.19 and
got a total share price of $83.25. Based on this information, Chevron seems to
be slightly overvalued.

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 Industry
PPS EPS P/E Avg. CVX PPS
Chevron 96.47 9.76 9.88 10.16 83.25
Exxon/Mobil 66.67 5.48 12.15
Conoco/Phillips 109.91 13.38 8.21
British
Petroleum 83.27 7.99 10.42

Trailing Price to Earnings

To calculate the average trailing P/E ratios, we used the price per share as
stated in Chevrons 10K and the PPS as reported for our competitors. Just as
before, we took the average of the industry, which equals 12.07 and then
multiplied that with Chevrons EPS to get a total of $98.85. When we compared
this to our current PPS of $96.47, we could determine that Chevron was fairly
valued.

Industry
PPS EPS P/E Avg. CVX PPS
Chevron 96.47 8.19 10.73 12.07 98.85
Exxon/Mobil 66.67 6.92 12.85
Conoco/Phillips 109.91 6.44 12.44
British
Petroleum 83.27 6.03 12.26

Price to Book
To calculate the method of price to book we used our annual report to
determine the current price per share and the book value of equity per share. In
calculating P/B we divided PPS by BPS, which resulted in a ratio of 2.72. We
then did the same with our competitors and determined an industry average of
2.72, resulting in the same ratio as Chevron. We then multiplied the average by
our company’s BPS which gave us a share price of 96.40. In a result to a close
ratio, we can determine that Chevron is fairly valued.

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 Industry
PPS BPS P/B Avg. CVX PPS
Chevron 96.47 35.49 2.710 2.71 96.39
Exxon/Mobil 66.67 21.71 3.070
Conoco/Phillips 109.91 52.92 2.070
British
Petroleum 83.27 27.77 2.990

Dividend Yield
As stated by investopedia, dividend yield shows how much a company
pays out in dividends each year relative to its share price. In the absence of any
capital gains, the dividend yield is the return on investment for a stock. To
calculate this ratio you take the current price per share and divide it by the
dividends per share. We did this for each company and then calculated an
industry average of .02. We then took in industry average and divided it into
Chevrons DPS to compute a share price of $101.76. This shows that Chevron is
slightly undervalued as to the industry.

Industry
PPS DPS D/P Avg. CVX PPS
Chevron 96.47 2.32 0.024 0.02 101.76
Exxon/Mobil 66.67 1.4 0.021
Conoco/Phillips 109.91 1.64 0.015
British
Petroleum 83.27 2.6 0.031

Price Earnings Growth

The price earnings growth model uses the P/E ration and an estimated
earnings growth rate. To determine Chevrons, we divided the company’s P/E
ratio by our estimated earnings growth rate of 7 percent. We then calculated an
average for the industry and came up with a total of 1.62. Second we multiplied
the industry average with our growth rate and then by our EPS. We got a share
price of 93.20 for Chevron. We can see that the company is fairly valued.

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 Industry
PPS EPS PEG Avg. CVX PPS
Chevron 96.47 8.19 1.53 1.63 93.20
Exxon/Mobil 66.67 6.92 1.66
Conoco/Phillips 109.91 6.44 0.80
British
Petroleum 83.27 6.03 2.51

Price to EBITDA
This ratio used current share prices and earnings before interest, taxes,
depreciation, and amortization. It is calculated by dividing PPS by EBITDA. We
used Chevrons 10K and yahoo finance to determine PPS and EBITDA. After
calculating each companies P/EBITDA ratio, we calculated an average for the
industry, equaling 2.49. We then multiplied this by Chevron’s EBITDA and got a
share price of $79.70. This shows that Chevron is overvalued.

Industry
PPS EBITDA P/EBITDA Avg. CVX PPS
Chevron 96.47 31.97 3.02 2.49 79.70
Exxon/Mobil 66.67 70.77 0.94
Conoco/Phillips 109.91 30.23 3.64
British
Petroleum 83.27 35.04 2.38

Enterprise Value to EBITDA

To determine the ratio of enterprise value to EBITDA you first have to
calculate EV. To do this you add the company’s price per share and book value
of liabilities and then subtract cash. We then determined our competitors
EV/EBITDA and computed the industries average, totaling 6.10. We calculated a
share price by multiplying the industry average by Chevrons EBITDA and then
subtracted its book value of liabilities and added its cash. We came up with
$180.63 and then divided this by the total number of shares to get the
company’s share price of $85.60. With these results we determined that
Chevron is undervalued.

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 Industry
EV EBITDA EV/EBITDA Avg. CVX PPS
Chevron 180.63 31.97 5.65 6.10 85.60
Exxon/Mobil 462.83 70.77 6.54
Conoco/Phillips 148.73 30.23 4.92
British
Petroleum 255.09 35.04 7.28

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 Cost of Equity

The cost of equity, or Ke, is what a company expects to return on

stockholder’s equity for that year. The capital asset pricing model, or CAPM, is
one of a variety of ways to find this number. Its ease of use and broad use
around the world makes it a valuable asset. CAPM is computed by finding the
market risk premium using a long run average of riskier stocks and subtracting
that from a risk-free rate such as a Treasury bill. This is then multiplied by beta
which is a measure of the volatility of the stock compared to the market. A beta
of one means that it moves directly with the market. We then add back in the
risk-free rate to arrive at a good estimate of the cost of equity.
The beta for Chevron was calculated using a regression analysis of the
return on Chevron stock to the market risk premium of different risk free rates.
We used the 3-month, 1-year, 2-year, 5-year, 7-year, and 10-year rates over
different periods of 72, 60, 48, 36, and 24 months. These 30 combinations were
used to assess the stability of beta over time. The highest adjusted r2 out of the
30 regressions gives us the beta. The 3-month Treasury bill over 48 months
gave us the highest R2 of 17.66%. This represents how much is explained by
the percentage of movement in the security to the benchmark index. This
means our beta was 1.0557 and the risk-free rate is 4%. Yahoo finance puts
Chevron’s beta at .77 while MSN has it at 1. Obviously, there are different ways
to compute it and many different outcomes. We used the traditional long run
S&P average of 12.6% to find the market risk premium. Using CAPM, we came
to Ke of 13.07%.

3 Month 72 Months 60 Months 48 Months 36 Months 24 Months

Rate
RF 4.0 4.0 4.0 4.0 4.0
R2 0.1751 0.1237 0.1766 0.1529 0.1576
Beta 0.6723 0.7098 1.0557 1.0224 0.7672

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Ke 9.78178 10.10428 13.07902 12.79264 10.59792

Cost of Debt

The cost of debt, or Kd, is the effective rate a company pays on its debt.
The process consists of finding all relevant liabilities and finding their weight
against total liabilities. This weight is then multiplied by an interest rate that
best reflects what the company will be paying. These numbers are often found
in the footnotes of the 10-K or substitutes can be found at sites such as the St.
Louis Fed. We used a rate of 5.8% for employee benefits and other liabilities per
the 10-K and Moody’s AA corporate bond rate. Short-term debt and accrued
liabilities were found to be 5.25% using the St. Louis Fed system for their short
term commercial paper. Long-term debt was used by calculating the average of
each portion of long term debt as provided in the 10-K. Each interest rate was
found based on the length of time to maturity. This multiplied rate is the value
rate which is then added together to arrive at the weighted average cost of debt.
Using this method Chevron’s before tax weighted average cost of debt is 5.91%
and 3.85% after a 35% corporate tax rate.

Weighted Average Cost of Capital

Once we have the cost of equity and debt, we can find the weighted
average cost of capital. WACC is a great measure to find the return on a firm as
a whole and to see what percentage of the company is financed by debt or
equity. The value of debt is just the book value, as financial statements are
much better at getting this as close as possible to market value. The value of
equity is simply the market capitalization, or the stock price per share multiplied
by the number of shares outstanding. The sum of the value of equity and the
value of debt provides the value of the firm as a whole. Thus, WACC before tax
is figured as: WACC=(Vd/Vd+Ve)Kd + (Ve/Vd+Ve)Ke. This is 11.25% for

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Chevron before tax and 10.72% after tax. After tax multiplies 1 minus the tax
rate of 35%, times the weighted average cost of debt.
Intrinsic Valuations

The intrinsic valuations of the firm give a broad look at the value of the
firm compared to the method of comparables. The main difference between the
two is intrinsic valuations are based on financial theory as opposed to market
consensus. Using our forecasted financial statements and estimates, Chevron
can be valued at different per share prices for different inputs such as cost of
equity, weighted average cost of capital, return on equity, and different growth
rates. This is called a sensitivity analysis, and shows us what range of prices can
be achieved using these varying inputs. Calculated prices valued under the
observed price means the stock is overvalued. A calculated price above the
observed price means the stock is undervalued, which is favorable. A comfort
zone of +/- $5 shows which prices fairly value the company accounting for
errors. The methods used were the discounted dividends model, free cash flows,
long run residual income, and abnormal earnings growth model. The following is
a discussion of each model and their outcomes.

Discounted Dividends Model

The discounted dividends valuation model is based on one of the oldest

stock valuation methods. Any stock is worth the present value of all current and
future dividends to its shareholders. This is done by discounting the dividends
back to present value. This model is based on the assumption that dividends will
grow at a constant rate over an infinite time period. This is costly assumption
over time if the wrong growth rate is selected. Chevron’s dividends are
consistently released each quarter with either a stable increase or the same
dividend as before. Tougher times usually call for the dividend to stay the same
and better times will cause a higher growth rate. One must go back a long time
to find a decrease in Chevron’s dividends. The problem with this model is that as

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dividends remain fairly stable, the actual stock price is focused on the much
more volatile earnings. The graph below shows the growing spread and
difference in volatility between earnings per share and dividends per share over
the last couple of years.

DPS Vs. EPS

10

6 EPS
4 DPS

0
2003 2004 2005 2006

To calculate the value of Chevron’s stock using this model, we began with
the forecasted dividends from our cash flow statement. These were obtained by
looking at the long run average growth rate, the industry average, and assessing
the recent trend throwing out any outliers. This resulted in our assumption of 8
percent growth. A multi-stage growth model is an option, but Chevron has been
fairly consistent in the long run. With Chevron’s grasp on market share and the
increase in profits due to the increasing reliance on oil, it is best to assume an
optimistic rate rather than decrease it over time. Once we had forecasted
dividends out 10 years, we found the present value of each year’s dividends and
summed them up to find the total present value. The final perpetuity year
assumes an initial growth rate of zero for all future years and is then discounted
to the present using the present value factor. Summing up the present value of
annual dividends and the present value of the perpetuity gives us our estimated
share price. Because this price per share is for year end 2007, we must make it

93
time consistent to the valuation date of November 1st. This yielded a price per
share of $30.34 which is significantly lower than our observed price of $89.04.
Performing a sensitivity analysis that changes the perpetuity growth rate
and the cost of equity yielded a highest price per share of $69.15 with a growth
rate of 8% and a cost of equity of 11%. This would be hard to attain and still
comes up well short of the observed price. Thus, this model clearly states
Chevron is overvalued. A comfort zone of +/- $5 was of no help in this
valuation. This model generally proves to have a lower adjusted r² relative to
other valuation models.

Sensitivity
Analysis

Perpetuity Growth Rate (g)

0 0.02 0.04 0.06 0.08
Ke 0.11 $32.46 $35.52 $40.32 $48.97 $69.15
0.13 $30.34 $32.46 $35.52 $40.32 $48.97
0.15 $28.79 $30.34 $32.46 $35.52 $40.32
0.17 $27.60 $28.79 $30.34 $32.46 $35.52
0.19 $26.67 $27.60 $28.79 $30.34 $32.46

Overvalued Undervalued $5 +/-

PPS: $89.04

Free Cash Flows Model

The free cash flow model is another form of valuation which focuses on
the amount of cash the company is going to make in the future if forecasted
properly. This cash is important to the value of the firm because it should be
used for operations that increase shareholder value. This model uses forecasted
free cash flows and a free cash flow perpetuity discounted to the present value
to calculate the value of the firm. Subtracting out liabilities gives us the
estimated market value of equity which is then calculated on a per share basis to
find our estimated price per share. Making it time consistent to November 1st,

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2007 yields a price of $61.77. This model uses weighted average cost of capital
before tax as opposed to cost of equity in the discounted dividends model. This
is due to the fact that free cash flows involve both debt and equity in its
valuation and weighted average cost of capital includes both. We use before tax
because taxes are already calculated in free cash flows and there would be no
reason to account for taxes twice.
The calculations using the sensitivity analysis gave us a much better
reflection of the value of the company excluding a few outliers. This is expected
as regression analyses of the discounted dividends model prove to have a lower
adjusted r² than the free cash flows model. This sensitivity analysis was figured
changing the perpetuity growth rate and the weighted average cost of capital.
An 11.25% WACC and a 6% perpetuity growth rate yield the best computed
price at $89.72 which is 66 cents off of the observed price. A perpetuity growth
rate of 6% is fairly high and unreasonable. This model generally gives
reasonable prices around $60 a share which leaves the stock overvalued, but is a
much more reasonable price than the dividend discount model produced.

Sensitivity
Analysis

Perpetuity Growth Rate (g)

0 0.01 0.03 0.05 0.06
WACC BT 0.07 $74.17 $80.52 $102.71 $169.31 $302.49
0.09 $66.74 $70.50 $81.77 $104.31 $126.86
0.1125 $61.77 $64.16 $70.67 $81.34 $89.72
0.13 $59.24 $61.03 $65.68 $72.65 $77.62
0.15 $57.22 $58.56 $61.93 $66.65 $69.79

Overvalued Undervalued $5 +/-

PPS: $89.04

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Residual Income Model

The residual income model is an accounting based method of valuation

that calculates the amount of income left over after dividends and normal
earnings are taken out. Normal earnings are what has been gained from the
previous year’s equity at the cost of equity. The leftover residual income is the
added value to the firm above the expected return at the cost of equity. This
can then be used to increase shareholder’s value and increase the stock price.
The book value of equity uses the difference between forecasted earnings and
dividends added to the previous year’s book value of equity. Multiplying the
previous year’s book value of equity by the cost of equity shows the normal
earnings of the firm that year. Earnings then subtract the normal earnings to the
residual income left over. Taking the present value of residual income and its
perpetuity and adding it to the initial book value of equity yields the gross price
of the firm. Dividing this by the number of shares outstanding gives the
estimated price per share which is once again brought back to November 1st,
2007 for a time consistent price.
The residual income figure and its present value have the tendency to
revert to zero over time. This is due to the inability of earnings to keep up with
equity and continue to add value above the market rate. A residual income
value of zero means the company is receiving returns above the expected rate.
Chevron has a high residual income which shows that they are making very good
returns on their equity. The stockholder’s letter quickly points out that total
stockholder return for 2006 was 22.6%.This is nearly impossible to keep us over
many years and the present value of residual income accounts for this decrease
below.

Forecast Years

0 1 2 3 4 5 6 7 8 9 10 Perp

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

96
PV Residual Income
(Annual) $7,362 $6,066 $4,957 $4,009 $3,201 $2,515 $1,935 $1,477 $1,038 $698

Looking at the sensitivity analysis for the residual income valuation shows
that this is a very clear and consistent model. This was expected as this model
has the most explanatory power of all the models with an adjusted r2 of around
50%. Our computed cost of equity of 13% and 0% perpetuity growth rate
provided a time consistent price of $68.59. This is $20.45 lower than the
observed share price but is consistent with the other valuations. We used
negative perpetuity growth ratios because of the decrease in residual income
over time. Residual income reverts to the cost of equity over time, so the
perpetuity must reflect it. Overall, this model proves that Chevron’s stock as of
November 1st, 2007 is overvalued.

Sensitivity
Analysis

Perpetuity Growth Rate (g)

0 -0.1 -0.2 -0.3 -0.4
Ke 0.11 $76.90 $68.59 $65.64 $64.13 $63.21
0.13 $68.59 $62.08 $59.51 $58.14 $57.28
0.15 $60.74 $55.47 $53.21 $51.96 $51.16
0.17 $53.12 $48.75 $46.74 $45.59 $44.84
0.19 $45.59 $41.89 $40.10 $39.03 $38.33

Overvalued Undervalued $5 +/-

PPS: $89.04

Abnormal Earnings Growth Model

The abnormal earnings growth model is another accounting based model

like residual income. Abnormal earnings are earnings above those expected.
Any earnings above what is expected is what causes market value to deviate
from book value. In this case, a dividend re-investment program, or drip, invests
the previous year’s dividends at our cost of equity. These returns are added to
the next year’s earnings to form cumulative dividend earnings. Subtracting this

97
 number from the normal earnings yields the abnormal earnings growth. For
Chevron, this turned out to be negative for all forecasted years. This means that
Chevron is not adding any value over their expected earnings. Thus, there is no
reason for the market value of the stock to be above its book value.
The abnormal earnings growth is then back to year one instead of year
zero in the other models. The present values are then summed and added to
the present value of the terminal value perpetuity. The core earnings are then
added to the total present value of abnormal earnings to find the total adjusted
perpetuity. Dividing this by the capitalization rate, represented by our cost of
equity, and dividing by the shares outstanding yields our estimated price.
Making this time consistent price time consistent to November 1st gives us a price
of $49.59. This is slightly lower than our residual income model’s computed
price but each model different and has its advantages. We are confident in this
model as there is a check figure between the year by year change in residual
income and the abnormal earnings growth. Below are the computed numbers.

Forecast Years
0 1 2 3 4 5 6 7 8 9 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Abnormal Earnings Growth
(AEG) -$573 -$594 -$616 -$640 -$660 -$683 -$707 -$727 -$751
∆ Residual Income -$573 -$594 -$616 -$640 -$660 -$683 -$707 -$727 -$751

Thus, our models are correctly calculated and should reflect one another.
The sensitivity analysis for this model used our same cost of equity and
perpetuity growth rates as the residual income model. The results were fairly
stable but were not able to reach our current share price which reinforces the
fact the Chevron’s stock is overvalued. We have a great deal of confidence in
this model because of the link to a highly explanatory residual income model and
their consistent results.

98
 Sensitivity
Analysis

Perpetuity Growth Rate (g)

0 -0.1 -0.2 -0.3 -0.4
Ke 0.11 $61.05 $66.30 $68.17 $69.12 $69.70
0.13 $49.59 $52.56 $53.73 $54.36 $54.75
0.15 $41.10 $42.88 $43.64 $44.06 $44.33
0.17 $34.67 $35.78 $36.29 $36.59 $36.78
0.19 $29.70 $30.42 $30.77 $30.98 $31.12

Overvalued Undervalued $5 +/-

PPS: $89.04

Long Run Residual Income Model

The long run residual income model is the last and most unique model
used to value the firm. This model is an equation based on assumptions of the
long run return on equity, long run growth rate of equity, and our calculated cost
of equity. We first calculated the return on equity by dividing the earnings of
each year by the previous years ending book value of equity. We then
calculated the growth of book value of equity for each year in order to find a
useable growth rate. We then looked at the averages over the forecasted years
as well as industry averages and analyst forecasts. A return on equity of 20%
was based on the relative stability of return on equity over the forecasted years.
Book value of equity growth was harder to assess but a growth rate of 8% was
chosen due to the past history, industry average of 7%, and analyst
recommendations of 6-8%. The formula for this model is calculated by:

P=BVE0 + BVE0 [(ROE – Ke)/(Ke – g)]

We already have our book value of equity and cost of equity, so plugging
in these numbers gave us a time consistent price per share of $50.64. This
correlates with the other valuation models at placing Chevron’s stock at well
overpriced. A sensitivity analysis was conducted but in a different fashion than
99
the other models. With three different variables, three different sensitivity
analyses can be conducted with one constant and two changing variables. The
results were hard to assess as the prices had a great degree of volatility. When
we looked at our assumed numbers in the sensitivity analyses, we found that
each price was between $40 and $60. This further solidifies our assessment that
Chevron is overvalued at $80 a share while each model has shown the firm to be
valued around $30 to $60.

Sensitivity
Analysis

Growth Rate (g)

ROE constant at
0.02 0.04 0.06 0.08 0.1 20%
Ke 0.11 $35.64 $45.82 $64.15 $106.92 $320.75
0.13 $23.02 $28.13 $36.17 $50.64 $84.40
0.15 $14.12 $16.68 $20.39 $26.22 $36.71
0.17 $7.45 $8.59 $10.16 $12.41 $15.96
0.19 $2.22 $2.52 $2.91 $3.43 $4.20

Growth Rate (g)

Ke constant at
0.02 0.04 0.06 0.08 0.1 13%
ROE 0.13 n/a n/a n/a n/a n/a
0.15 $6.58 $8.04 $10.34 $14.47 $24.12
0.17 $13.15 $16.08 $20.67 $28.94 $48.23
0.19 $19.73 $24.12 $31.01 $43.41 $72.35
0.21 $26.31 $32.15 $41.34 $57.88 $96.46

ROE
0.13 0.15 0.17 0.19 0.21 G Constant at 8%
Ke 0.11 $23.76 $47.52 $71.28 $95.04 $118.80
0.13 n/a $14.47 $28.94 $43.41 $57.88
0.15 n/a n/a $10.49 $20.97 $31.46
0.17 n/a n/a n/a $8.27 $16.55
0.19 n/a n/a n/a n/a $6.87

Overvalued Undervalued $5 +/-

100
Conclusion

After reviewing each intrinsic valuation model, it is conclusive that

Chevron’s per share price of $89.04 on November 1st, 2007 is well overvalued
compared to the true value of the firm. The average of each calculated time
consistent price came out to be $52.07. This is a $36.97 differential between
calculated and observed share prices. Each valuation model brings a different
aspect of financial theory. The strong explanatory power of each model and the
level of consistency in their observed values makes us confident to place the true
value of Chevron at between $40 and $60.

Div. Avg.
Disc. FCF RI AEG LR RI Avg.
$30.34 $61.77 $68.59 $49.59 $50.04 $52.07

101
 Credit Analysis

A credit analysis of Chevron is performed in order to assess the company’s

ability to take on credit and pay it off without problems. The Altman-Z score
model is used to assess this risk and how likely the company is to have to file for
bankruptcy. A score of less than 1.81 predicts bankruptcy in the near future. A
score between 1.81 and 2.67 is a gray area that should be avoided. Lastly, a
score above 3 puts the company in good standing. The model uses five
variables which measure liquidity, profitability, return on assets, market leverage,
and the sales generating potential of assets. The calculation is done using the
following formula:

Z-Score = (1.2) (working capital/total assets) + (1.4) (retained earnings/total

assets) + (3.3) (EBIT/total assets) + (0.6) (market value of equity/book value of
total liabilities) + (1.0) (sales/total assets)

2002 2003 2004 2005 2006

Z Score 2.52 3.16 3.87 3.55 3.85

This shows that Chevron is in good financial position but has had a brief
stint in the upper end of the gray area in 2002. That year produced a significant
decrease in net income on the balance sheet but that is expected over the life of
a company. It would be ridiculous to think a company of Chevron’s size and
scope would be in danger of bankruptcy but this model is still a good assessment
of the company’s financial standing.

102
 Analyst Recommendation

All of our research of the Chevron Corporation has taken us through every
relevant aspect of the company and industry. After careful analysis of the
company, industry, accounting analysis, financial analysis, forecasting financial
statements, ratios, and valuation models, we have found the stock price of the
firm to be highly overvalued. This causes us to recommend the investor to sell
this stock.
A model is only as good as the assumptions it is based on, so doubt plays
a large role in forecasting and valuing a stock. The goal is to become as certain
as possible and we feel that by looking at Chevron from all angles, we are able
to give a fair and balanced report.
The oil and gas industry is soaring based on the surge in the price of oil
and the overall exuberation of the recent market. It is only a matter of time
before things level out and prices become more fairly valued. When forecasting
out the financial statements, we took into account this recent surge and focused
on choosing less optimistic growth rates. This will hopefully give an accurate
look into the future value of the company.
The conclusion that the stock is overvalued is a consideration of all
aspects of the analysis. The method of comparables and intrinsic valuations
gave the best look and each result gave us a fair look at what different models
see in the company. This company should remain overvalued for some time due
to increasing tensions in the middle east and the continuing dependence on oil
and gas.

103
 Appendix

Chevron's Trend Analysis 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

LIQUIDITY
Current Ratio 0.89 1.21 1.52 1.37 1.28
Quick Asset Ratio 0.66 0.93 1.23 1.13 1.02
A/R Turnover 1.11 1.09 1.09 1.10 1.09
A/R Days 330.29 335.44 334.93 332.61 333.60
Inventory Turnover 26.89 33.08 42.28 37.20 33.13
Inventory Days 13.57 11.03 8.63 9.81 11.02
Working Capital Turnover -47.00 36.21 15.54 20.77 25.95
PROFITABILITY
Gross Profit Margin 24.93% 25.30% 24.28% 23.18% 27.26%
Operating Expense Ratio 4.21% 3.70% 3.02% 2.49% 2.49%
Net Profit Margin 1.15% 6.02% 8.83% 7.28% 8.36%
Asset Turnover 1.28 1.47 1.62 1.54 1.54
Return on Assets 1.46% 8.87% 14.30% 11.20% 12.92%
Return on Equity 3.58% 19.92% 29.47% 22.50% 24.86%
CAPITAL STRUCTURE
Debt to equity ratio 1.45 1.24 1.06 1.01 0.92
Times interest earned 7.36 26.94 50.62 52.28 70.90
Debt service margin 0.93 1.16 1.44 1.7 3.28

Exxon Mobil's Trend Analysis 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

LIQUIDITY
Current Ratio 1.15 1.20 1.40 1.58 1.55
Quick Asset Ratio 0.68 0.71 0.91 1.13 1.09
A/R Turnover 1.08 1.08 1.08 1.07 1.07
A/R Days 337.18 339.18 339.04 340.74 339.96
Inventory Turnover 20.38 21.26 24.31 30.50 26.29
Inventory Days 17.91 17.17 15.01 11.97 13.88
Working Capital Turnover 39.28 31.30 16.74 13.28 13.56
PROFITABILITY
Gross Profit Margin 18.19% 19.67% 20.80% 20.79% 22.93%
Operating Expense Ratio 6.15% 5.65% 4.75% 4.01% 3.91%
Net Profit Margin 5.70% 9.07% 8.70% 10.07% 10.81%
Asset Turnover 1.32 1.36 1.49 1.72 1.67
Return on Assets 7.51% 12.34% 12.97% 17.34% 18.04%
Return on Equity 15.36% 23.92% 24.89% 32.50% 34.70%
CAPITAL STRUCTURE
Debt to equity ratio 1.05 0.94 0.92 0.87 0.92
Times interest earned 43.99 154.43 64.64 119.82 103.06
Debt service margin 3.2 5.99 8.09 7.74 7.42

ConocoPhillips' Trend Analysis 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

LIQUIDITY
Current Ratio 0.85 0.80 0.96 0.92 0.95
Quick Asset Ratio 0.37 0.39 0.65 0.66 0.56
A/R Turnover 1.08 1.03 1.07 1.07 1.08
A/R Days 336.96 356.08 341.52 341.17 337.59
Inventory Turnover 12.86 22.57 31.38 40.77 28.62
Inventory Days 28.38 16.17 11.63 8.95 12.75
Working Capital Turnover -29.80 -72.65 -241.79 -104.69 -137.61

104
PROFITABILITY
Gross Profit Margin 13.25% 7.56% 15.79% 16.98% 21.48%
Operating Expense Ratio 3.46% 1.13% 1.68% 1.33% 1.47%
Net Profit Margin -0.52% 2.31% 5.95% 7.40% 8.28%
Asset Turnover 0.74 2.48 1.47 1.71 2.90
Return on Assets -0.38% 5.74% 8.75% 12.64% 24.00%
Return on Equity -1.00% 13.78% 19.03% 25.66% 18.82%
CAPITAL STRUCTURE
Debt to equity ratio 1.60 1.40 1.17 1.03 0.99
Times interest earned 3.36 10.28 28.17 43.21 26.81
Debt service margin 0.26 0.57 0.83 1.64 0.93

Shell's Trend Analysis 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

LIQUIDITY
Current Ratio 0.85 0.9 1.13 1.15 1.20
Quick Asset Ratio 1.28 1.41 0.85 0.28 0.24
A/R Turnover 5.58 6.73 7.11 4.62 5.34
A/R Days 65.37 54.24 51.35 79.00 68.31
Inventory Turnover 4.62 5.59 14.52 12.77 11.33
Inventory Days 78.99 65.29 25.14 28.57 32.22
Working Capital Turnover 21.08 38.59 37.01 23.73 21.06
PROFITABILITY
Gross Profit Margin 17.00% 17.00% 16.00% 18.00% 18.00%
Operating Expense Ratio 6.00% 6.00% 7.00% 9.00% 8.00%
Net Profit Margin 6.00% 6.00% 7.00% 9.00% 8.00%
Asset Turnover 1.05 1.15 1.42 1.40 1.36
Return on Assets 7.00% 8.00% 11.00% 14.00% 12.00%
Return on Equity 12.00% 14.00% 21.00% 27.00% 23.00%
CAPITAL STRUCTURE
Debt to equity ratio 0.79 0.74 1.05 1.24 1.05
Times interest earned 7.4 9.1 18.41 24.88 22.90
Debt service margin 2.31 2.42 3 3.97 3.26

BP's Trend Analysis 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

LIQUIDITY
Current Ratio 0.97 0.91 0.97 1.05 0.99
Quick Asset Ratio 1.38 1.28 0.73 0.35 0.35
A/R Turnover 9.29 7.02 6.17 6.98 8.15
A/R Days 39.31 52.02 59.14 52.31 44.77
Inventory Turnover 15.31 10.95 9.43 9.50 11.32
Inventory Days 23.84 33.32 38.71 38.44 32.25
Working Capital Turnover -144.71 -35.63 -116.45 74.36 -263.85
PROFITABILITY
Gross Profit Margin 13.00% 24.00% 25.00% 23.00% 22.00%
Operating Expense Ratio 7.00% 11.00% 13.00% 13.00% 13.00%
Net Profit Margin 5.00% 8.00% 9.00% 8.00% 8.00%
Asset Turnover 1.12 0.97 1.01 1.18 1.26
Return on Assets 6.00% 8.00% 10.00% 10.00% 10.00%
Return on Equity 12.00% 19.00% 22.00% 25.00% 25.00%
CAPITAL STRUCTURE
Debt to equity ratio 1.29 1.49 1.53 1.60 1.57
Times interest earned -12.79 0 0 15.72 -58.65
Debt service margin 1.47 0.82 1.1 1.08 1.09

105
Cost of Debt
Value
Current Liabilities 12/31/2007 Weight Interest Rate Weight
Short-Term Debt $2,159 0.0501 5.25% 0.00262877
Accrued Liabilities $4,546 0.1054 5.25% 0.00553516
Other Taxes Payable $1,403 0.0325 12.25% 0.00398598
Total Current Liabilities $8,108 0.1880
Long-Term Liabilities
Long-Term Debt $7,405 0.1717 7.20% 0.01236514
Deferred Income Taxes $11,647 0.2701 4.87% 0.01315481
Reserves For Employee Benefits $4,749 0.1101 5.80% 0.0063881
Other Liabilities $11,209 0.2600 5.80% 0.01507774
Total Long-Term Liabilities $35,010 0.8120
Total Liabilities $43,118 1
0.0591357
Weighted Average Cost
Of Debt Before Taxes 5.91%

Weighted Average Cost

of Debt After Taxes 3.85%
(35% Corporate Tax Rate)

106
Cost of Equity

Ke = Rf + B(Rm – Rf)
Rf = 4%
B = 1.0577
Rm = 12.6

Ke = 4 + 1.0577(12.6-4)
Ke = 13.07%

Weighted Average Cost of Capital

Components:
Ve = Market Capitalization 186.25B
Vd = 63.693 B
Vf = 249.943
Ke = 13.079%
Kd = 5.91%
T = 35%

WACCBT=(63.693/249.943)*5.91% + (186.25/249.943)*13.079%
WACCBT= 11.25%
WACCAT=(63.693/249.943)*5.91%(1-.35) + (186.25/249.943)*13.079%
WACCAT= 10.72%

107
 Regression Analysis

3 Month 72 Months 60 Months 48 Months 36 Months 24 Months

Rate
RF 4.0 4.0 4.0 4.0 4.0
R2 0.1751 0.1237 0.1766 0.1529 0.1576
Beta 0.6723 0.7098 1.0557 1.0224 0.7672
KE 9.78178 10.10428 13.07902 12.79264 10.59792

1 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months

RF 4.1 4.1 4.1 4.1 4.1
R2 0.1748 0.1235 0.1765 0.1535 0.1582
Beta 0.6708 0.7084 1.0541 1.023 0.7677
KE 9.8018 10.1214 13.05985 12.7955 10.62545

2 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months

RF 3.97 3.97 3.97 3.97 3.97
R2 0.1751 0.1235 0.1759 0.1541 0.1585
Beta 0.67 0.708 1.0516 1.0231 0.767
KE 9.8861 10.22164 13.255628 13.003973 10.74261

5 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months

RF 4.2 4.2 4.2 4.2 4.2
R2 0.1758 0.1236 0.1743 0.1548 0.1585
Beta 0.6707 0.7094 1.0472 1.0254 0.7669
KE 9.96802 10.30084 13.20592 13.01844 10.79534

7 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months

RF 4.33 4.33 4.33 4.33 4.33
R2 0.1763 0.1238 0.1736 0.155 0.1586
Beta 0.6713 0.7102 1.0455 1.0264 0.7672
KE 10.015911 10.345394 13.185385 13.023608 10.828184

10 Year 72 Months 60 Months 48 Months 36 Months 24 Months

Rate
RF 4.53 4.53 4.53 4.53 4.53
R2 0.1764 0.1238 0.173 0.1552 0.1586
Beta 0.6717 0.7106 1.044 1.0272 0.7676

108
 KE 10.084959 10.406662 13.16388 13.024944 10.878052

SUMMARY
OUTPUT- 3
Month

Regression Statistics
Multiple R 0.440713599
R Square 0.194228476
Adjusted R
Square 0.157602498
Standard Error 0.032693104
Observations 24

ANOVA
Significance
df SS MS F F
Regression 1 0.00566808 0.00566808 5.303024935 0.03112188
Residual 22 0.023514459 0.001068839
Total 23 0.029182539

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019286725 0.007033223 2.742231335 0.011893155 0.004700713 0.033872737 0.004700713 0.033872737
X Variable 1 0.767152727 0.333134797 2.302829767 0.03112188 0.076273447 1.458032008 0.076273447 1.458032008

SUMMARY
OUTPUT- 3
Month

Regression Statistics
Multiple R 0.420872359
R Square 0.177133542
Adjusted R
Square 0.152931588
Standard Error 0.048379492
Observations 36

ANOVA
Significance
df SS MS F F
Regression 1 0.017130616 0.017130616 7.318976711 0.010586059
Residual 34 0.079579558 0.002340575
Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.01431593 0.008336695 1.71721898 0.095036776 -0.00262627 0.031258132 -0.00262627 0.031258132

109
X Variable 1 1.022399844 0.377916272 2.705360736 0.010586059 0.254381579 1.790418108 0.254381579 1.790418108

SUMMARY
OUTPUT 3-
Month

Regression Statistics
Multiple R 0.440621965
R Square 0.194147716
Adjusted R
Square 0.176629188
Standard Error 0.046483736
Observations 48

ANOVA
Significance
df SS MS F F
Regression 1 0.023946207 0.023946207 11.08242185 0.001722562
Residual 46 0.099393936 0.002160738
Total 47 0.123340143

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.017690077 0.006936072 2.550446047 0.014152297 0.003728489 0.031651664 0.003728489 0.031651664
X Variable 1 1.055740542 0.31713185 3.329027162 0.001722562 0.417387247 1.694093836 0.417387247 1.694093836

SUMMARY
OUTPUT 3-
Month

Regression Statistics
Multiple R 0.372249626
R Square 0.138569784
Adjusted R
Square 0.123717539
Standard Error 0.04676259
Observations 60

ANOVA
Significance
df SS MS F F
Regression 1 0.020402038 0.020402038 9.329888023 0.003402449
Residual 58 0.126830912 0.00218674
Total 59 0.14723295

110
 Standard Lower Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.016120601 0.006268653 2.571621435 0.012707681 0.00357253 0.028668673 0.00357253 0.028668673
X Variable 1 0.709795486 0.232378004 3.05448654 0.003402449 0.244640376 1.174950596 0.244640376 1.174950596

SUMMARY
OUTPUT 3-
Month

Regression Statistics
Multiple R 0.432082025
R Square 0.186694877
Adjusted R
Square 0.175076232
Standard Error 0.049135158
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.038793739 0.038793739 16.068559 0.000150635
Residual 70 0.168998462 0.002414264
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.012384504 0.00582237 2.127055462 0.036941167 0.000772153 0.023996854 0.000772153 0.023996854
X Variable 1 0.672314003 0.167719551 4.008560714 0.000150635 0.337807911 1.006820095 0.337807911 1.006820095

SUMMARY
OUTPUT 1-Year

Regression Statistics
Multiple R 0.44137395
R Square 0.194810964
Adjusted R
Square 0.158211462
Standard Error 0.032681285
Observations 24

ANOVA
Significance
df SS MS F F
Regression 1 0.005685079 0.005685079 5.322776407 0.030840986
Residual 22 0.023497461 0.001068066
Total 23 0.029182539

111
 Standard Lower Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019344495 0.007021778 2.75492851 0.011557121 0.00478222 0.03390677 0.00478222 0.03390677
X Variable 1 0.76768349 0.332746188 2.307114303 0.030840986 0.077610135 1.457756845 0.077610135 1.457756845

SUMMARY
OUTPUT 1-Year

Regression Statistics
Multiple R 0.421556439
R Square 0.177709831
Adjusted R
Square 0.153524826
Standard Error 0.048362548
Observations 36

ANOVA
Significance
df SS MS F F
Regression 1 0.017186349 0.017186349 7.347934446 0.010447245
Residual 34 0.079523825 0.002338936
Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.014485497 0.008317257 1.74161943 0.090617132 -0.0024172 0.031388197 -0.0024172 0.031388197
X Variable 1 1.023032256 0.377404167 2.71070737 0.010447245 0.256054715 1.790009797 0.256054715 1.790009797

SUMMARY
OUTPUT 1-Year

Regression Statistics
Multiple R 0.440429411
R Square 0.193978066
Adjusted R
Square 0.17645585
Standard Error 0.046488629
Observations 48

ANOVA
Significance
df SS MS F F
Regression 1 0.023925282 0.023925282 11.07040724 0.001731559
Residual 46 0.099414861 0.002161193
Total 47 0.123340143

112
 Standard Lower Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.017937815 0.006918482 2.592738485 0.012723084 0.004011633 0.031863998 0.004011633 0.031863998
X Variable 1 1.054064954 0.316800294 3.327222151 0.001731559 0.416379048 1.691750861 0.416379048 1.691750861

SUMMARY
OUTPUT 1-Year

Regression Statistics
Multiple R 0.371963045
R Square 0.138356507
Adjusted R
Square 0.123500585
Standard Error 0.046768379
Observations 60

ANOVA
Significance
df SS MS F F
Regression 1 0.020370637 0.020370637 9.313222314 0.00342916
Residual 58 0.126862313 0.002187281
Total 59 0.14723295

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.01627857 0.006256027 2.602062051 0.011742327 0.003755772 0.028801368 0.003755772 0.028801368
X Variable 1 0.708392985 0.232126256 3.05175725 0.00342916 0.243741803 1.173044167 0.243741803 1.173044167

SUMMARY
OUTPUT 1-Year

Regression Statistics
Multiple R 0.431789568
R Square 0.186442231
Adjusted R
Square 0.174819978
Standard Error 0.049142789
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.038741242 0.038741242 16.04183096 0.000152373
Residual 70 0.16905096 0.002415014

113
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.012543697 0.005819304 2.155532046 0.034560222 0.000937461 0.024149933 0.000937461 0.024149933
X Variable 1 0.67084933 0.167493525 4.005225456 0.000152373 0.336794032 1.004904628 0.336794032 1.004904628

SUMMARY
OUTPUT 2-Year

Regression Statistics
Multiple R 0.441711719
R Square 0.195109243
Adjusted R
Square 0.158523299
Standard Error 0.032675231
Observations 24

ANOVA
Significance
df SS MS F F
Regression 1 0.005693783 0.005693783 5.332901771 0.030698092
Residual 22 0.023488756 0.001067671
Total 23 0.029182539

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019276787 0.007029154 2.742405193 0.011888492 0.004699215 0.033854359 0.004699215 0.033854359
X Variable 1 0.76696565 0.332119306 2.309307639 0.030698092 0.07819237 1.455738931 0.07819237 1.455738931

SUMMARY
OUTPUT 2-Year

Regression Statistics
Multiple R 0.42219773
R Square 0.178250923
Adjusted R
Square 0.154081833
Standard Error 0.048346633
Observations 36

ANOVA
Significance
df SS MS F F
Regression 1 0.017238678 0.017238678 7.375160572 0.010318521

114
SUMMARY
OUTPUT 2-Year

Regression Statistics
Multiple R 0.439824578
R Square 0.19344566
Adjusted R
Square 0.17591187
Standard Error 0.04650398
Observations 48

ANOVA
Significance
df SS MS F F
Regression 1 0.023859615 0.023859615 11.03273505 0.001760095
Residual 46 0.099480528 0.00216262

Residual 34 0.079471495 0.002337397

Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.014505701 0.008311924 1.745167632 0.089989054 -0.00238616 0.031397563 -0.00238616 0.031397563
X Variable 1 1.023149624 0.376750128 2.715724686 0.010318521 0.257501249 1.788798 0.257501249 1.788798

115
Total 47 0.123340143

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.018087169 0.006910502 2.617345253 0.011953498 0.004177051 0.031997287 0.004177051 0.031997287
X Variable 1 1.051556554 0.316585515 3.321556119 0.001760095 0.414302974 1.688810133 0.414302974 1.688810133

SUMMARY
OUTPUT 2-Year

Regression Statistics
Multiple R 0.371953348
R Square 0.138349293
Adjusted R
Square 0.123493246
Standard Error 0.046768575
Observations 60

ANOVA
Significance
df SS MS F F
Regression 1 0.020369575 0.020369575 9.312658731 0.003430067
Residual 58 0.126863375 0.0021873
Total 59 0.14723295

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.016396647 0.006246044 2.625125005 0.011055905 0.003893831 0.028899463 0.003893831 0.028899463
X Variable 1 0.708034424 0.232015783 3.051664911 0.003430067 0.243604378 1.172464469 0.243604378 1.172464469

SUMMARY
OUTPUT 2- Year

Regression Statistics
Multiple R 0.432120098
R Square 0.186727779
Adjusted R
Square 0.175109604
Standard Error 0.049134164
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.038800576 0.038800576 16.07204103 0.00015041

116
Residual 70 0.168991625 0.002414166
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.012702967 0.005814501 2.184704526 0.032261051 0.00110631 0.024299624 0.00110631 0.024299624
X Variable 1 0.670030852 0.167131875 4.008995015 0.00015041 0.336696843 1.003364861 0.336696843 1.003364861

SUMMARY
OUTPUT 5-Year

Regression Statistics
Multiple R 0.441679272
R Square 0.195080579
Adjusted R
Square 0.158493333
Standard Error 0.032675813
Observations 24

ANOVA
Significance
df SS MS F F
Regression 1 0.005692947 0.005692947 5.331928428 0.030711796
Residual 22 0.023489593 0.001067709
Total 23 0.029182539

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019253906 0.007032464 2.737860472 0.012010957 0.004669468 0.033838345 0.004669468 0.033838345
X Variable 1 0.766883078 0.332113859 2.309096886 0.030711796 0.078121093 1.455645063 0.078121093 1.455645063

SUMMARY
OUTPUT 5-Year

Regression Statistics
Multiple R 0.423000168
R Square 0.178929142
Adjusted R
Square 0.154779999
Standard Error 0.048326678
Observations 36

ANOVA
Significance
df SS MS F F

117
Regression 1 0.017304268 0.017304268 7.409337166 0.010159351
Residual 34 0.079405905 0.002335468
Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.014574615 0.00830138 1.755685879 0.088148656 -0.00229582 0.031445049 -0.00229582 0.031445049
X Variable 1 1.025414985 0.376712456 2.722009766 0.010159351 0.259843169 1.790986802 0.259843169 1.790986802

SUMMARY
OUTPUT 5-Year

Regression Statistics
Multiple R 0.43799306
R Square 0.191837921
Adjusted R
Square 0.17426918
Standard Error 0.046550306
Observations 48

ANOVA
Significance
df SS MS F F
Regression 1 0.023661317 0.023661317 10.91927547 0.00184907
Residual 46 0.099678826 0.002166931
Total 47 0.123340143

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.018439549 0.006894344 2.674590879 0.01032527 0.004561955 0.032317144 0.004561955 0.032317144
X Variable 1 1.047168508 0.316898119 3.3044327 0.00184907 0.409285688 1.685051327 0.409285688 1.685051327

SUMMARY
OUTPUT 5-year

Regression Statistics
Multiple R 0.372106449
R Square 0.138463209
Adjusted R
Square 0.123609127
Standard Error 0.046765483
Observations 60

ANOVA

118
 Significance
df SS MS F F
Regression 1 0.020386347 0.020386347 9.32155913 0.003415771
Residual 58 0.126846603 0.00218701
Total 59 0.14723295

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.016713771 0.006219686 2.687236905 0.009385254 0.004263716 0.029163826 0.004263716 0.029163826
X Variable 1 0.709351499 0.232336376 3.053122849 0.003415771 0.244279716 1.174423282 0.244279716 1.174423282

SUMMARY
OUTPUT 5-Year

Regression Statistics
Multiple R 0.432957209
R Square 0.187451944
Adjusted R
Square 0.175844115
Standard Error 0.049112284
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.038951052 0.038951052 16.14875086 0.000145544
Residual 70 0.168841149 0.002412016
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.013069913 0.005804263 2.251778332 0.027476163 0.001493676 0.024646149 0.001493676 0.024646149
X Variable 1 0.670693302 0.166899295 4.018550841 0.000145544 0.337823159 1.003563446 0.337823159 1.003563446

SUMMARY
OUTPUT 7-Year

Regression Statistics
Multiple R 0.441770897
R Square 0.195161525
Adjusted R
Square 0.158577958
Standard Error 0.03267417
Observations 24

119
ANOVA
Significance
df SS MS F F
Regression 1 0.005695309 0.005695309 5.334677325 0.030673112
Residual 22 0.02348723 0.001067601
Total 23 0.029182539

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019267515 0.007030099 2.740717339 0.011933835 0.004687982 0.033847049 0.004687982 0.033847049
X Variable 1 0.767197154 0.332164263 2.309692041 0.030673112 0.078330639 1.45606367 0.078330639 1.45606367

SUMMARY
OUTPUT 7-Year

Regression Statistics
Multiple R 0.423273923
R Square 0.179160814
Adjusted R
Square 0.155018485
Standard Error 0.048319859
Observations 36

ANOVA
Significance
df SS MS F F
Regression 1 0.017326673 0.017326673 7.421024457 0.010105529
Residual 34 0.0793835 0.002334809
Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.014636699 0.00829441 1.764646239 0.086605944 -0.00221957 0.031492967 -0.00221957 0.031492967
X Variable 1 1.02642618 0.376786895 2.724155733 0.010105529 0.260703086 1.792149275 0.260703086 1.792149275

SUMMARY
OUTPUT 7-Year

Regression Statistics
Multiple R 0.437272415
R Square 0.191207165
Adjusted R
Square 0.173624712
Standard Error 0.046568469
Observations 48

120
ANOVA
Significance
df SS MS F F
Regression 1 0.023583519 0.023583519 10.87488565 0.001885159
Residual 46 0.099756624 0.002168622
Total 47 0.123340143

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.01860421 0.006886569 2.701521025 0.009632082 0.004742267 0.032466154 0.004742267 0.032466154
X Variable 1 1.045524997 0.317045849 3.297709151 0.001885159 0.407344813 1.68370518 0.407344813 1.68370518

SUMMARY
OUTPUT 7-Year

Regression Statistics
Multiple R 0.37233094
R Square 0.138630329
Adjusted R
Square 0.123779127
Standard Error 0.046760947
Observations 60

ANOVA
Significance
df SS MS F F
Regression 1 0.020410952 0.020410952 9.334620571 0.003394903
Residual 58 0.126821998 0.002186586
Total 59 0.14723295

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.016860995 0.006207469 2.71624329 0.008687108 0.004435397 0.029286594 0.004435397 0.029286594
X Variable 1 0.710169833 0.232441616 3.05526113 0.003394903 0.244887391 1.175452276 0.244887391 1.175452276

SUMMARY
OUTPUT 7-Year

Regression Statistics
Multiple R 0.433422085
R Square 0.187854704
Adjusted R
Square 0.176252628
Standard Error 0.04910011

121
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.039034742 0.039034742 16.19147377 0.000142905
Residual 70 0.168757459 0.002410821
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.013230503 0.005799938 2.281145793 0.025585937 0.001662893 0.024798114 0.001662893 0.024798114
X Variable 1 0.671292107 0.166827772 4.02386304 0.000142905 0.338564611 1.004019602 0.338564611 1.004019602

SUMMARY
OUTPUT 10-Year

Regression Statistics
Multiple R 0.441811091
R Square 0.19519704
Adjusted R
Square 0.158615088
Standard Error 0.032673449
Observations 24

ANOVA
Significance
df SS MS F F
Regression 1 0.005696345 0.005696345 5.335883566 0.030656154
Residual 22 0.023486194 0.001067554
Total 23 0.029182539

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.019299713 0.007025487 2.747099787 0.01176323 0.004729746 0.033869681 0.004729746 0.033869681
X Variable 1 0.767563179 0.332285171 2.309953152 0.030656154 0.078445915 1.456680443 0.078445915 1.456680443

SUMMARY
OUTPUT 10-Year

Regression Statistics
Multiple R 0.423472328
R Square 0.179328813
Adjusted R
Square 0.155191425

122
Standard Error 0.048314914
Observations 36

ANOVA
Significance
df SS MS F F
Regression 1 0.017342921 0.017342921 7.429503708 0.010066673
Residual 34 0.079367253 0.002334331
Total 35 0.096710173

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.014720861 0.008286005 1.776593337 0.084584479 -0.00211833 0.03156005 -0.00211833 0.03156005
X Variable 1 1.027241165 0.37687082 2.725711597 0.010066673 0.261347514 1.793134815 0.261347514 1.793134815

SUMMARY
OUTPUT 10-Year

Regression Statistics
Multiple R 0.436617736
R Square 0.190635047
Adjusted R
Square 0.173040157
Standard Error 0.046584936
Observations 48

ANOVA
Significance
df SS MS F F
Regression 1 0.023512954 0.023512954 10.83468235 0.001918486
Residual 46 0.099827189 0.002170156
Total 47 0.123340143

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.018777058 0.006878242 2.729920994 0.008947676 0.004931875 0.032622242 0.004931875 0.032622242
X Variable 1 1.044004794 0.317171679 3.291607867 0.001918486 0.405571327 1.68243826 0.405571327 1.68243826

SUMMARY
OUTPUT 10-Year

Regression Statistics
Multiple R 0.372326827
R Square 0.138627266

123
Adjusted R
Square 0.123776012
Standard Error 0.04676103
Observations 60

ANOVA
Significance
df SS MS F F
Regression 1 0.020410501 0.020410501 9.334381152 0.003395285
Residual 58 0.126822449 0.002186594
Total 59 0.14723295

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.017004006 0.00619675 2.744019837 0.008063511 0.004599862 0.029408149 0.004599862 0.029408149
X Variable 1 0.7105815 0.232579339 3.055221948 0.003395285 0.245023375 1.176139624 0.245023375 1.176139624

SUMMARY
OUTPUT 10-Year

Regression Statistics
Multiple R 0.433566645
R Square 0.187980036
Adjusted R
Square 0.176379751
Standard Error 0.049096322
Observations 72

ANOVA
Significance
df SS MS F F
Regression 1 0.039060786 0.039060786 16.20477711 0.000142093
Residual 70 0.168731416 0.002410449
Total 71 0.207792202

Standard Lower Upper

Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 0.013369091 0.005797242 2.306112286 0.024070316 0.001806856 0.024931325 0.001806856 0.024931325
X Variable 1 0.671662522 0.166851296 4.025515757 0.000142093 0.338888109 1.004436934 0.338888109 1.004436934

124
Discounted Dividends WACC(BT) 0.1125 Kd 0.059 Ke 0.13

Forecasted Years
0 1 2 3 4 5 6 7 8 9 10 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
EPS (Earnings Per Share) 6% $7.84 $8.19 $8.68 $9.20 $9.75 $10.34 $10.96 $11.62 $12.31 $13.05 $13.84
DPS (Dividends Per Share) 8% $2.01 $2.32 $2.51 $2.71 $2.92 $3.16 $3.41 $3.68 $3.98 $4.29 $4.64 $4.64
BPS (Book Value Equity per Share) $32.67 $38.54 $44.72 $51.21 $58.04 $65.23 $72.78 $80.71 $89.05 $97.81 $107.01
PV Factor 0.8850 0.7831 0.6931 0.6133 0.5428 0.4803 0.4251 0.3762 0.3329 0.2946
PV Dividends Year by Year $2.05 $1.96 $1.88 $1.79 $1.71 $1.64 $1.56 $1.50 $1.43 $1.37
Total PV of Annual Dividends $16.89
Continuing (Terminal) Value Perpetuity 35.6923
Sensitivity
PV of Terminal Value Perpetuity $10.51 Analysis
Estimated Price per Share $27.40
Time Consistent Implied Share Price $30.34 Perpetuity Growth Rate
Observed Share Price (Nov.1, 2007) $89.04 0 0.02 0.04 0.06 0.08
Difference Between Computed and Observed -$58.70 Ke 0.11 $32.46 $35.52 $40.32 $48.97 $69.15
Initial Cost of Equity (Ke) 0.13 0.13 $30.34 $32.46 $35.52 $40.32 $48.97
Perpetuity Growth Rate (g) 0 0.15 $28.79 $30.34 $32.46 $35.52 $40.32
0.17 $27.60 $28.79 $30.34 $32.46 $35.52
0.19 $26.67 $27.60 $28.79 $30.34 $32.46

Overvalued Undervalued $5 +/-

125
Residual Income Valuation WACC(BT) 0.1125 Kd 0.059 Ke 0.13

Forecast Years
0 1 2 3 4 5 6 7 8 9 10 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Earnings $17,281 $18,318 $19,417 $20,582 $21,817 $23,126 $24,513 $25,984 $27,543 $29,196
Dividends $4,895 $5,296 $5,718 $6,161 $6,668 $7,195 $7,765 $8,398 $9,052 $9,790
Book Value Equity $68,934 $81,319 $94,341 $108,040 $122,460 $137,610 $153,540 $170,289 $187,875 $206,366 $225,771
Normal Earnings $8,961 $10,572 $12,264 $14,045 $15,920 $17,889 $19,960 $22,138 $24,424 $26,828
Residual Income (Annual) $8,320 $7,746 $7,152 $6,537 $5,897 $5,237 $4,553 $3,847 $3,119 $2,368 $12,600
PV Factor 0.8850 0.7831 0.6931 0.6133 0.5428 0.4803 0.4251 0.3762 0.3329 0.2946
PV of Annual Residual Income $7,362 $6,066 $4,957 $4,009 $3,201 $2,515 $1,935 $1,447 $1,038 $698
∆ Residual Income -$573 -$594 -$616 -$640 -$660 -$683 -$707 -$727 -$751
Total PV of Annual Residual Income $33,229
Continuing (Terminal) Value Perpetuity $96,923
PV of Terminal Value Perpetuity $28,552
Sensitivity
Initial Book Value of Equity $68,934 Analysis
Book Value of Liabilities $63,693
Estimated Price per Share $61.95 Perpetuity Growth Rate (g)
Time Consistent Price $68.59 0 -0.1 -0.2 -0.3 -0.4
Observed Share Price $89.04 Ke 0.11 $76.90 $68.59 $65.64 $64.13 $63.21
Difference Between Computed and
Observed -$20.45 0.13 $68.59 $62.08 $59.51 $58.14 $57.28
Cost of Equity (Ke) 0.13 0.15 $60.74 $55.47 $53.21 $51.96 $51.16
Perpetuity Growth Rate (g) 0 0.17 $53.12 $48.75 $46.74 $45.59 $44.84
0.19 $45.59 $41.89 $40.10 $39.03 $38.33

Overvalued Undervalued $5 +/-

126
Discounted Free Cash Flow WACC(BT) 0.1125 Kd 0.059 Ke 0.13

Forecasted Years
0 1 2 3 4 5 6 7 8 9 10 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Cash From Operations $25,416 $28,402 $31,704 $35,352 $39,381 $43,828 $48,734 $54,145 $60,111 $66,683
Cash Investments ($12,952) ($13,729) ($14,553) ($15,426) ($16,352) ($17,333) ($18,373) ($19,475) ($20,644) ($21,882)
Book Value of Debt and Preferred Stock $63,693
Annual Free Cash Flow $12,464 $14,673 $17,151 $19,926 $23,029 $26,495 $30,361 $34,670 $39,467 $44,801 $51,521
PV Factor 0.8989 0.8080 0.7263 0.6528 0.5868 0.5275 0.4741 0.4262 0.3831 0.3443
PV of Free Cash Flows $11,204 $11,855 $12,456 $13,008 $13,514 $13,975 $14,395 $14,776 $15,119 $15,427
Total PV of Annual Free Cash Flows $135,730
Continuing (Terminal) Value Perpetuity 137,131
Sensitivity
PV of Terminal Perpetuity $47,221 Analysis
Value of Firm $182,951
Book Value of Liabilities $63,693 Perpetuity Growth Rate (g)
Estimated Market Value of Equity $119,258 0 0.01 0.03 0.05 0.06
Number of Shares 2,110 WACC BT 0.07 $74.17 $80.52 $102.71 $169.31 $302.49
Estimated Price Per Share $56.52 0.09 $66.74 $70.50 $81.77 $104.31 $126.86
Time Consistent Implied Share Price $61.77 0.1125 $61.77 $64.16 $70.67 $81.34 $89.72
Observed Share Price $89.04 0.13 $59.24 $61.03 $65.68 $72.65 $77.62
Difference Between Computed and
Observed -$27.27 0.15 $57.22 $58.56 $61.93 $66.65 $69.79
Initial WACC BT 0.1125
Perpetuity Growth Rate (g) 0 Overvalued Undervalued $5 +/-

127
Abnormal Earnings Growth WACC(BT) 0.1125 Kd 0.059 Ke 0.13

Forecast Years
0 1 2 3 4 5 6 7 8 9 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Earnings $17,281 $18,318 $19,417 $20,582 $21,817 $23,126 $24,513 $25,984 $27,543 $29,196
Dividends $4,895 $5,296 $5,718 $6,161 $6,668 $7,195 $7,765 $8,398 $9,052 $9,790
Dividends invested at 13% (Drip) $636 $688 $743 $801 $867 $935 $1,009 $1,092 $1,177
Cum-Dividend Earnings $18,954 $20,105 $21,325 $22,618 $23,993 $25,449 $26,994 $28,635 $30,372
Normal Earnings $19,527 $20,699 $21,941 $23,257 $24,653 $26,132 $27,700 $29,362 $31,124
Abnormal Earnings Growth (AEG) -$573 -$594 -$616 -$640 -$660 -$683 -$707 -$727 -$751 -$661
PV Factor 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333
PV of AEG -$507 -$465 -$427 -$392 -$358 -$328 -$300 -$274 -$250
Residual Income Check Figure -$573 -$594 -$616 -$640 -$660 -$683 -$707 -$727 -$751
Error $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00
Core Earnings $17,281
Total PV of AEG -$3,302
-
Continuing (Terminal) Value -$5,085 $5,084.62
PV of Terminal Value -$1,693
Sensitivity
Total PV of AEG -$4,995 Analysis
Total Adjusted Perp (t+1) $12,286
Capitalization Rate (perpetuity) 0.13 Perpetuity Growth Rate (g)
Estimated Price per Share $44.79 0 -0.1 -0.2 -0.3 -0.4
Time Consistent Price $49.59 Ke 0.11 $61.05 $66.30 $68.17 $69.12 $69.70
Observed Share Price $89.04 0.13 $49.59 $52.56 $53.73 $54.36 $54.75
Difference Between Computed and
Observed -$39.45 0.15 $41.10 $42.88 $43.64 $44.06 $44.33
Cost of Equity (Ke) 0.13 0.17 $34.67 $35.78 $36.29 $36.59 $36.78
Perpetuity Growth Rate (g) 0 0.19 $29.70 $30.42 $30.77 $30.98 $31.12

Overvalued Undervalued $5 +/-

128
Long Run Residual Income Perpetuity WACC BT 0.1125 Kd 0.059 Ke 0.13

Forecast Years
0 1 2 3 4 5 6 7 8 9 10 Perp
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Earnings $18,154 $20,287 $22,646 $25,251 $28,129 $31,305 $34,810 $38,675 $42,936 $47,631
Dividends $4,895 $4,895 $5,718 $6,161 $6,161 $7,174 $7,765 $7,765 $9,052 $9,769
Ending Book Value of Equity $68,934 $81,319 $95,435 $110,248 $126,262 $144,050 $162,744 $182,916 $205,303 $228,830 $254,234

ROE 26.34% 24.95% 23.73% 22.90% 22.28% 21.73% 21.39% 21.14% 20.91% 20.82%
BE Growth 17.97% 17.36% 15.52% 14.53% 14.09% 12.98% 12.39% 12.24% 11.46% 11.10%
Average ROE 22.62%
Average BE Growth 13.96% Overvalued Undervalued $5 +/-
Sensitivity
Analysis
Book Value of Equity $68,934
Cost of Equity (Ke) 0.13 Growth Rate (g)
ROE constant at
Long Run Return On Equity 20% 0.02 0.04 0.06 0.08 0.1 20%
Long Run Growth Rate of Equity 8% Ke 0.11 $35.64 $45.82 $64.15 $106.92 $320.75
Estimated Price Per Share $45.74 0.13 $23.02 $28.13 $36.17 $50.64 $84.40
Time Consistent Implied Share Price $50.64 0.15 $14.12 $16.68 $20.39 $26.22 $36.71
Observed Share Price $89.04 0.17 $7.45 $8.59 $10.16 $12.41 $15.96
Difference Between Computed and
Observed -$38.40 0.19 $2.22 $2.52 $2.91 $3.43 $4.20

Growth Rate (g)

0.02 0.04 0.06 0.08 0.1 Ke constant at 13%
ROE 0.13 n/a n/a n/a n/a n/a
0.15 $6.58 $8.04 $10.34 $14.47 $24.12
0.17 $13.15 $16.08 $20.67 $28.94 $48.23
0.19 $19.73 $24.12 $31.01 $43.41 $72.35
0.21 $26.31 $32.15 $41.34 $57.88 $96.46

ROE
0.13 0.15 0.17 0.19 0.21 G Constant at 8%
Ke 0.11 $23.76 $47.52 $71.28 $95.04 $118.80
0.13 n/a $14.47 $28.94 $43.41 $57.88
0.15 n/a n/a $10.49 $20.97 $31.46
0.17 n/a n/a n/a $8.27 $16.55
0.19 n/a n/a n/a n/a $6.87

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Altman-Z Score Analysis
Weight 2002 2003 2004 2005 2006
Working Capital 1.2 -2100 3315 18286 9325 7895
Total Assets 77359 81470 93208 125833 132628

Retained
Earnings 1.4 30942 35315 45414 55738 69464
Total Assets 77359 81470 93208 125833 132628

EBIT 3.3 7037 13150 20957 25679 32427

Total Assets 77359 81470 93208 125833 132628

Mkt. Value of
Equity 0.6 31604 36295 45230 62676 68935
BV of Liab 45755 45175 47976 63157 63693

Sales 1 98913 121761 153447 198200 210118

Total Assets 77359 81470 93208 125833 132628

Ratios 2002 2003 2004 2005 2006

-0.02715 0.04069 0.19618 0.07410 0.05952

0.39997 0.43347 0.48723 0.44295 0.52375

0.09096 0.16140 0.22484 0.20407 0.24449

0.69072 0.80343 0.94276 0.99238 1.08230

1.27862 1.49455 1.64628 1.57510 1.58426

Weighted 2002 2003 2004 2005 2006

-0.03258 0.04882 0.23542 0.08892 0.07143

0.55997 0.60686 0.68212 0.62013 0.73325

0.30018 0.53265 0.74197 0.67343 0.80683

0.41443 0.48205 0.56565 0.59543 0.64938

1.27862 1.49455 1.64628 1.57510 1.58426

Altman-Z Score Σ= 2.52063 3.16494 3.87146 3.55303 3.84516

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1. Chevron: www.chevron.com
2006 Annual Report
2002 10K - 2007 10K
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2006 Annual Report
2002 10K - 2007 10K
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2006 Annual Report
2002 10K - 2007 10K
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2006 Annual Report
2002 10K - 2007 10K
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2006 Annual Report
2002 10K - 2007 10K
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2006 Annual Report
2002 10K - 2007 10K
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15. US Department of Energy

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16. St. Louis Fed
17. Business Analysis and Valuations – Palepu and Healy

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