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Financial analysis

As a Global Business Management graduate of London Metropolitan University, you are to advise a family friend, Gunter Merkel who has 20 years’ experience in large mining projects. He is considering setting up his own company back in West Lancashire to extract shale gas, on some land he inherited.
So far the current indicated gas reserves discovered from test drill holes is estimated at 11 million cubic metres.

He currently owns shares in a major publicly listed UK chemical company valued at over £6 million, which could be sold, to start the business.

At present your best assessment of the future costs and revenues are as follows:

• Payment of £3.26m at the commencement of the project (1 December 2015) for exploration work to date and the licence to frack for shale gas for a period up to and including 2030.
• Payment of £2.5 million for further exploration and drill holes during 2016

Based on the expected energy price you expect to receive and the gas extracted, the operational cost to extract the gas is estimated as follows:

Year Income£ Operational Mining- Costs
2015 0 0
2016 3,000,000 £1.65m
2017 3,500,000 £2m
2018 4,000,000 £2m
2019 4,500,000 £2m
2020 5,000,000 £0.7m

The extraction license granted by the government requires the operator of the mine to clear and environmentally improve the area on completion. Estimates indicate this will involve a £0.815 m cost at the end of 2021.

The cost of capital of 12% p.a. With the exception of the exploration costs to date, assume all costs and revenues arise at the end of each year.

Calculations indicate a net present value of £1,107,800

1. Evaluate the viability of the project and the reliability of information on which the net present value is based.
2. Outline the risks of using his own capital for this investment project.

Unfortunately by the 12 November 2015 the price of shares have fallen by over a third, following a stock market dip on the Shanghai Stock Exchange.
You find yourself as his advisor/potential financial manager needing to raise extra capital of just over £2 million and to assess the options in relation to long term funding from equity or debt.

3. Identify the potential sources of finance available to this business venture, whilst
considering the return for investors and gearing for a new company.
4. Following your successful operational advice you decide to investigate a career in Financial Management. Identify what makes up this role and prepare a reasoned personal list of which areas you would enjoy, have talents for and those you would perhaps rather avoid.
Gunter asks for your advice on the internal environment of business and management accounting, particularly costing for decision making and budgeting.


5. Prepare some notes which identify the types of costs, with an example of each, likely to be incurred by this mining business and the impact on both profit and cash flow.

6. Provide a short report on budgetary planning, control and motivation
Market research completed by Gunter has indicted 3 potential customers for the shale gas. However due to location, problems of supply and pipelines and potential demand it is necessary to determine the most profitable mix. Due to the current lack of investment in pipelines for shale gas there is a limited output per month.

There are three customers and demand has been estimated as follows:
SS1. 810,000 cubic metres per annum at a selling price of £2.90
SS2. 140,000 cubic metres per annum at a selling price of £3.40
SS3. 60,000 cubic metres per annum at a selling price of £3.45

The costs per customer per cubic metre are as follows: 1 2 3

£ £ £ Raw materials gas 0.98 0.98 0.98
Pipeline delivery 0.40 0.48 0.60
Delivery costs are £0.08 per cubic metre capacity per mile.

Due to connection problems the pipeline delivery capacity available is only 975000 cubic metres in 2016 with the fixed costs being £250,000 per annum.
7. You have been asked to determine the most profitable supply mix, showing the actual amounts to be supplied to each customer.

8. Calculate the contribution and profit following your recommendations for the optimum production plan.

9. Discuss the limitations of marginal costing for decision making with reference to your supply mix and suggest other techniques, with their advantages for managing various sources of finance.

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