Master Graduation Thesis

BUSINESS VALUATION AND CASE STUDY at PETROM OMV
BUCHAREST UNIVERSITY OF ECONOMIC STUDIES
FACULTY OF ACCOUNTING AND MANAGEMENT

INFORMATION SYSTEMS
MASTER GRADUATION THESIS
SCIENTIFIC TUTOR:
LECT. UNIV., PHD. MIHAI STERE
GRADUATED:
ALEXANDRU NICOLAE GRIGORAS
BUCHAREST
June 2014
1
BUCHAREST UNIVERSITY OF ECONOMIC STUDIES
FACULTY OF ACCOUNTING AND MANAGEMENT

INFORMATION SYSTEMS
BUSINESS VALUATION AND CASE

STUDY AT PETROM OMV
SCIENTIFIC TUTOR:
LECT. UNIV., PHD. MIHAI STERE
GRADUATED:
ALEXANDRU NICOLAE GRIGORAS
BUCHAREST
June 2014
2
SUMMARY
Page
Chapter 1 THE THEORY OF BUSINESS VALUATION 2
1.1. The need for Business Valuation 2
1.2. Business Valuation methods 6
1.2.1. Income/Earnings-based methods 6
1.2.2. Cash-Flow-based methods 11
1.2.3. Asset-based methods 15
Chapter 2 CASE STUDY at PETROM OMV 21
2.1. Company presentation and valuation background 21
2.2. Results 22
2.2.1. Income/Earnings-based method 22
2.2.2. Cash-Flow-based method 24
2.2.3. Asset-based method 27
2.3. Sensitivity Analysis 30
2.4. Comparison of results 37
Chapter 3 CONCLUSIONS 40
References 43
Appendices 45
3
Chapter 1
THE THEORY OF BUSINESS VALUATION
1.1. THE NEED FOR BUSINESS VALUATION
The real worth of a company

Valuation is described as ‘an art not a science’.1 The real worth of a company depends
on the view-points of the various parties:
 the various methods of valuation will often give widely differing results;
 it may be in the interests of the investors to argue that either a ‘high’ or ‘low’ value is
appropriate;
 the final figure will be a matter for negotiation between the interested parties.
Valuation: an art and not a science

The acquisition of a major competitor may enable a company to secure a dominant
position in the market place. It is therefore likely to place a higher value on the target company
than a potential purchaser from outside the industry.
A realistic valuation will therefore require a full industry analysis rather than an isolated
assessment of the business to be valued. In some cases, the circumstances giving rise to the
valuation may call for ‘a value as would be agreed between a willing buyer and a willing seller’.
2
Information requirements for valuation exercises

There is a wide variety of information that may be useful when trying to put a valuation
on a business, including:
 Financial statements (including statements of financial position and statement of profit or

loss and other comprehensive income, statements of changes in financial position and
statements of shareholders equity for past years – maybe as many as five);
 Supporting listings such as non-current assets with depreciation schedule, aged accounts
receivable summary, aged accounts payable summary and inventory summary;
1
ACCA- paper F9- FINANCIAL MANAGEMENT- Chapter 20- ‘Business valuations and market efficiency’.
2
Idem 1;
4
 Details of existing contracts (e.g. leases);

 Budgets or projections for the future (again , maybe up to five years depending on the
industry);
 Background information on the industry and key personnel.
Every organization wants to improve the way it does business in order to produce things
more efficiently and/or to make greater profits. A change to a business process might lead to a
competitive disadvantage by either reducing costs or differentiating the business. 3
This list is not exhaustive as much as much will depend on the situation. However, much
of the above information does have limitations which must be accounted for. For example,
budgets or projections may be very optimistic and perhaps unrealistic statements of financial
position may be out of date and unrealistic.
Much of the information may be subjective and this can add to the overall subjectivity
involved in valuing businesses. When valuing a company, the normal approach taken is to create
a range of values using the various valuation methods possible given the available information .
This range of values may vary significantly, especially if the company is a hard company to
value. This may be the case if the company is in an unusual trade or if it is growing rapidly for
instance.
An appropriate value can then be decided upon given the range of values calculated, the
reason or purpose of the valuation, and the relevance of the valuation methods to the particular
circumstances of the company.
The purpose of the valuation will impact on the valuation process: for instance, if a
company is being valued with a view to its sale then a higher value will be desired. If a company
is being valued for tax or divorce reasons then a lower value may be desired. Furthermore, those
valuing a company with a view to its purchase will often seek a lower value.
The relevance of the valuation methods used must also be considered.
For instance valued based on the current tangible assets of a company is likely to have little
relevance to a company which has significant intangible assets or which has significant future
growth prospects.
Equally a dividend based value will have less relevance when valuing a majority stake in
a company as a majority shareholder will control the earnings, cash flows and assets of the
company. Hence valuations based on these are likely to be of more relevance.
3
ACCA- paper P3 – BUSINESS ANALYSIS – Chapter 9 – ‘ Business process change’.
5
A valuation based on present value of future cash flows is considered particularly

relevant where a company has significant growth prospects as this growth can be reflected in the
estimates of the cash flows.
Business valuations and market

efficiency
Figure 1-Business valuation
Approaches and Valuing debt Market efficiency

available information
Irredeemable Preference Inefficient

shares markets
Valuing
shares Weak form
Redeemable Convertibles
efficiency
Semi-strong
from efficiency
Strong form
efficiency
Asset based Income/Earnings Cash-flow

based based
Book NRV Replacement Price Earnings DVM DCF

value cost Earnings yield
6
Valuing business and financial assets

Valuations of shares in both public and private companies are needed for several purposes by
investors including:
 to establish terms of takeovers and mergers, etc;

 to be able to make ‘buy and hold’ decision in general;
 to value companies entering the stock market;
 to establish values of shares held by retiring directors, which the articles of a company
specify must be sold;
 for fiscal purposes (capital gains tax (CGT), inheritance tax);
 divorce settlements, etc.
Approaches to valuations
The three main approaches are:
 Income/Earnings – based on the returns earned by the company;

 Cash-flow based – based on the cash-flow of the company;
 Asset-based – based on tangible assets owned by the company.
7
1.2. BUSINESS VALUATION METHODS

The business valuations methods can be best defined as a set of procedures or techniques
used to determine the business value.
Under each of the three broad approaches to business valuation, there are a number of
procedures, called business valuation methods, which can be used to calculate the business value.
The methods under each business valuation approach rely upon the same set of economic
principles. However, the procedural and mathematical details of each business valuation may
differ considerably.
1.2.1. Income / Earnings –based method of Business Valuations

Income-based methods of valuation are of particular use when valuing a majority
shareholding:
 Ownership bestows additional benefits of control not reflected in the dividend valuation
model;
 Majority shareholders can influence dividend policy and therefore are more interested in
earnings;
Price /Earnings ratio method:

The Price/Earnings is the price per share divided by the earnings per share and shows
how many years’ worth of earnings are paid for in the share price.4
Price/Earnings ratios are quoted for all listed companies and calculated as follows:
𝐏𝐫𝐢𝐜𝐞 𝐒𝐭𝐨𝐜𝐤 𝐩𝐞𝐫 𝐏𝐫𝐢𝐜𝐞 𝐒𝐡𝐚𝐫𝐞

Ratio Formulae =
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 (𝐄𝐏𝐒)
4
Kevin Garrett – ACCA freelance lecturer and writer, ‘Business valuation’;
8
This formulae then can be used to value shares in unquoted companies as:
Value of company = Total earnings x Price/Earnings ratio;
Value per Share = Earnings per Share x Price /Earnings ratio, using an adjusted Price
/Earnings multiple from a similar quoted company (or industry average).
Problems with the PE ratio valuation:

 It may be necessary to make an adjustment(s) to the PE ratio of the similar company to
make it more suitable, e.g. if the company being valued:
Adjustment 1 is a private company as its shares may be less liquid;

2 is a more risky company- fewer controls, management
- knowledge, etc;
Adjustment 3 has a higher protected growth level;
 It can be difficult to estimate the maintainable or normal ongoing level of earnings of the
company being valued. It may be necessary to adjust these earnings to obtain a
maintainable figure,
e.g. change a director’s emoluments from an abnormal to a normal level;
 Price/Earnings ratios are in part based upon historical accounting information (the
Earnings per Share) whereas the valuation should reflect future earnings prospects.5
The Price/Earnings ratio is the best known of the investment valuation indicators. The
P/E ratio has its imperfections, but is nevertheless the most widely reported and used valuation
by investment professionals and the investing public.
The financial reporting of both companies and investment research services use a basic
earnings per share (EPS) figure divided into the current stock price to calculate the P/E multiple,
(e.g. how many times a stock is trading (its price) per each dollar of EPS).
5
9
It’s not surprising that estimated EPS figures are often very optimistic during bull
markets, while reflecting pessimism during bear markets.
Also, as a matter of historical record, it’s no secret that the accuracy of stock analyst earnings
estimates should be looked at skeptically by investors. Nevertheless, analysts estimates and
opinions based on forward- looking projections of a company’s earnings do play a role in Wall
Street‘s stock-pricing considerations.
Historically, the average P/E ratio for the broad market has been around 15, although it
can fluctuate significantly depending on economic and market conditions. The ratio will also
vary widely among different companies and industries. 6
The basic choice for a suitable PE ratio will be that of a quoted company of comparable
size in the same industry.
However, since share prices are broadly based on expected future earnings, a
Price/Earnings ratio – based on a single year’s reported earnings – may be very different for
companies in the same sector, carrying the same systematic risk.
For example, a high PE ratio may indicate:
 Growth stock – the share price is high because continuous high rates of growth of
earnings are expected from the stock;
 No growth stock – the PE ratio is based on the last reported earnings, which perhaps were
exceptionally low yet the share price is based on future earnings which are expected to
revert to a ‘normal’ relatively stable level;
 Takeover bid – the share price has risen pending a takeover bid;
 High security share – shares in property companies typically have low income yields but
the shares are still worth buying because of the prospects of capital growth and level of
security.
Similarly, a low PE ratio may indicate:
 Losses expected – future profits are expected to fall from their most recent levels;
6
Richard Loth, article : ’Investment Valuation Ratios: Price/Earnings Ratio’ ,2012, / www.investopedia.com/-
financial online portal;
10
 Share price low – as noted previously, share prices may be extremely volatile – special
factors, such as a strike at a manufacturing plant of a particular company, may depress
the share price and hence the PE ratio.
Consequently, the main difficulty in trying to apply the model is finding a similar growth
prospects. A further difficulty is that the reported earnings are based on historical cost accounts,
which in general, makes a non-sense of trying to compare two companies.
Also, it is important to ensure that the earnings in the victim company reflect future
earnings prospects.
It would be unwise to value a company on freakishly high earnings. 7
Variations
The basic formula for calculating the P/E ratio is fairly standard. There is never a
problem with the numerator – an investor can obtain a current closing stock price from various
sources, and they’ll all generate the same currency figure, which, of course, is a per-share
number.
However, there are a number of variations in the numbers used for the EPS figure in the
denominator. The most commonly used EPS currency figures include the following:
 Basic earnings per Share – based on the last twelve months as of the most recent reported
quarterly net income. In investment research materials, this period is often identified as
trailing twelve months (T.T.M.).
As noted previously, diluted earnings per share could also be used, but this is not a
common practice. The term ‘trailing P/E’ is used to identify a P/E ratio calculated on this
basis.
 Estimated basic Earnings per Share – based on a forward twelve months projection as of
the most recent quarter. This EPS calculation is not a ‘hard number’, but rather an
estimate generated by investment research analysts.
7
ACCA- paper F9- FINANCIAL MANAGEMENT- Chapter 20- ‘Business valuations and market efficiency’
11
 The Value Line Investment Survey’s combination approach – this well-known and
respected independent stock research firm has popularized a P/E ratio that uses six
months of actual trailing EPS and six months of forward, or estimated, EPS as its
Earnings per Share component in this ratio.
 Cash Earnings per Share – some businesses will report cash earnings per share, which
uses operating cash flow instead of net income in order to calculate Earnings per Share
(EPS).
 Other Earnings per Share – often referred to as ‘headline EPS’, ‘whisper numbers’, and
‘proforma’, these other earnings per share metrics are all based on assumptions due to
special circumstances.
While the intention here is to highlight the impact of some particular operating aspect of
a company that is not part of its conventional financial reporting, investors should
remember that the reliability of these forms of Earnings per Share is questionable. 8
The growth investor views high P/E ratio stocks as attractive and buys and a low P/E
stocks as flawed, unattractive prospects.
Value investors are not inclined to buy growth stocks at what they consider to be
overpriced values, preferring instead to buy what they see as underappreciated and undervalued
stocks , at a bargain price, which, over time, will hopefully perform well.
Though this indicator gets a lot of investors’ attention, there is an important problem that
arises with this valuation indicator and investors should avoid basing an investment decision
solely on this measure. The ratio’s denominator (EPS) is based on accounting conventions
related to a determination of earnings that is susceptible to assumptions, interpretations and
management manipulation.
This means that the quality of the P/E ratio is only as good as the quality of the
underlying earnings number. Whatever the limitations of the P/E ratio, the investment
community makes extensive use of this valuation metric.
8
Richard Loth, article : ’Investment Valuation Ratios: Price/Earnings Ratio’ ,2012, / www.investopedia.com/-
financial online portal;
12
It will appear in most stock quote presentations on an update basis, e.g. the latest twelve-
months earnings (based on the most recent reported quarter) divided by the current stock price.
Investors considering a stock purchase should then compare this current P/E ratio against
the stock’s long term (three to five years) historical record. This information is readily available
in Value Line or Standard & Poor’s (S&P) stock reports, as well as from most financial websites,
such as Yahoo! Finance and Market Watch.
It’s also worthwhile to look at the current P/E ratio for the overall market (S&P 500), the
company’s industry segment, and two or three direct competitor companies. This comparative
exercise can help investors evaluate the P/E of their prospective stock purchase as being in a
high, low or moderate price range.
1.2.2. Cash –flow –based method of Business Valuations
Discounted Cash Flow Basis

This alternative cash flow based method is used when acquiring a majority shareholding
since any buyer of a business is obtaining a stream of future operating cash flows.9
The maximum value of the business is: Present Value (P.V.) of future cash flows and a
discount rate reflecting the systematic risk the flows should be used.
Discount rate represents the interest rate that is used in the Discounted Cash Flow
(D.C.F.) business valuation method to determine what the expected business income stream is
worth in present day equivalent currency.
It means that the discount rate represents the required rate of return to make a business
acquisition worthwhile. The idea is to look at a business purchase as an investment decision.
Given that point of view, the business purchase investment must be compared against other,
possibly safer, alternatives.
9
ACCA- paper F9- FINANCIAL MANAGEMENT- Chapter 20- ‘Business valuations and market efficiency’ ;
13
For example, if you could invest in the US Government bonds at 5% annual return, then
the business must produce returns that are higher, in order to account for the risks of owning and
operating the business.
Method
(1) Identify relevant ‘free’ cash flows , (i.e., excluding financing flows);
- Operating flows;
- Revenue from sale of assets;
- Tax;
- Synergies arising from any merger.
(2) Select a suitable time horizon;
(3) Calculate the P.V. over this horizon. This gives the value to all providers of finance; i.e.
equity+ debt;
(4) Deduct the value of debt to leave the value of equity. 10
Valuing a Business based on Cash Flow and Risk

Preferred by professional business appraisers and savvy investors, the Discounted Cash Flow
method lets you determine the value of a business based on three fundamentals:
 Business cash Flow stream;

 Discount rate which captures the business risk;
 Long-term (terminal) business value;
Discounted Cash Flow is considered the most accurate business valuation method. Its
strength lies in business value estimation based on the precise match the business earning power
and risk.11
According to IAS 7, ‘Statement of Cash Flows’ the cash flows enable users of the financial
statements to assess the liquidity, solvency and financial adaptability of a business.12
10
11
Richard Loth, article : ’Analyze Cash Flow-The Easy Way, november 2012, / www.investopedia.com/- financial
online portal;
14
Advantages
 Theoretically the best method;
 Can be used to value part of a company;
Weaknesses
 It relies on estimates of both cash flows and discount rates – may be unavailable;
 Difficulty in choosing a time horizon;
 Difficulty in valuing a company’s worth beyond this period;
 Assumes that the discount rate, tax and inflation rates are constant through the period.
Advantages and disadvantages of NPV

When appraising projects or investments, NPV is considered to be superior (in theory) to
most other methods. This is because it:
 Considers the time value of money – discounting Cash Flows to P.V. takes account of the
impact of interest, inflation and risk over time. These significant issues are ignored by
the basic methods of payback and annual rate of return (A.R.R.);
 Is an absolute measure of return – the NPV of an investment represents the actual surplus
raised by the project. This allows a business to plan more effectively.
 Is based on Cash Flows not profits – the subjectivity of profits makes them less reliable
than Cash Flows and therefore less appropriate for decision making. Neither A.R.R. nor
Payback is an absolute measure.
 Considers the whole life of the project – methods such as Payback only considers the
earlier Cash Flows associated with the project. NPV takes account of all relevant flows
associated with the project.
Discounting the flows takes account of the fact that later flows are less reliable which
A.R.R. ignores:
12
ACCA- P2 – CORPORATE REPORTING – Chapter 6 – ‘Group statement of Cash Flows’ ;
15
 Should lead to maximization of shareholder wealth. If the cost of capital reflects the
investors’ required return, then the NPV reflects the theoretical increase in their wealth.
For a company, this is considered to be the primary objective of the business.
However, there are some potential NPV drawbacks:
 It is difficult to explain to managers. To understand the meaning of the NPV calculated

requires an understanding of discounting. The method is not as intuitive as techniques
such as payback;
 It requires knowledge of the cost of capital. In practice, the calculation of the cost of
capital is more complex than identifying interest rates. It involves gathering data and
making a number of calculations based on that data and some estimates. The process may
be deemed too protracted for the appraisal to be carried out.
 It is relatively complex. For the reasons explained above, NPV may be rejected in favour
of simpler techniques. 13
Steps in Cash Flow Estimation

 Estimate the current earnings of the firm:
- If looking at cash flows to equity, look at earnings after interest expense;
e.g. net income;
- if looking at cash flows to the firm, look at operating earnings after taxes;
 Consider how much the firm invested to create future growth:

- If the investment is not expensed, it will be categorized as capital expenditures. To
the extent that depreciation provides a cash flow, it will cover some of these
expenditures.
- Increasing working capital needs are also investments for future growth;
 If looking at cash flows to equity, consider the cash flows from net debt issues (debt
issued minus debt repaid). 14
13
ACCA- paper F9- FINANCIAL MANAGEMENT- Chapter 3 – ‘Investment appraisal – Dscounted Cash-Flow
techniques’ ;
14
Aswath Damodaran , ‘Discounted Cash flow Valuation : The Inputs’ – Stern School of Business at New York
University;
16
1.2.3. Asset – based method of Business Valuation
The asset approach is defined in the International Glossary of Business Valuation Terms
as ‘a general way of determining a value indication of a business, business ownership interest, or
security using one or more methods based on the value of net assets and liabilities ‘.
A type of business valuation that focuses on a company’s net assets value, or the fair-
market value of its total assets minus its total liabilities is based on the book values. The asset
based approach basically asks what it would cost to recreate the business. There is some room
for interpretation in the asset approach in terms of deciding which of the company’s assets and
liabilities to include in the valuation, and how to measure the worth of each.
Types of asset-based measures15
MEASURES STRENGTHS WEAKNESSES

Book values  None  Historic cost value
(although could be fair
value)
NRV – assumes a break-up  Minimum acceptable to  Valuation problems
basis (NRV less liabilities) owners especially if quick sale
 Asset stripping  Ignores Goodwill
Replacement cost – going  Maximum to be paid for  Valuation problems –
concern assets by buyer similar assets for
comparison?
 Ignores Goodwill
Problems with asset-based valuations
The fundamental weaknesses:
 Investors do normally buy a company for its balance sheet assets, but for the earnings /
cash flows that all of its assets can produce in the future;
 We should value what is being purchased; i.e. the future income/ cash flows;
Subsidiary weaknesses:
15
17
The asset approach also ignores non-balance sheet intangible ‘assets’, e.g.:
 Highly-skilled workforce;
 Strong management team ;
 Competitive positioning of the company’s products;
It is quite common that the non-balance sheet assets are more valuable than the balance sheet
assets.
When asset based methods are useful

Asset stripping
Asset valuation models are useful in the unusual situation that a company is going to be
purchased to be broken up and its assets sold off. In a break-up situation we would value the
assets at their realizable value.
To set a minimum price in a takeover bid
Shareholders will be reluctant to sell at a price less than the net asset valuation even if the
prospect for income growth is poor. A standard defensive tactic in a takeover battle is to revalue
balance sheet assets to encourage a higher price.
In a normal going – concern situation we value the assets at their replacement cost.
To value property investment companies
The market value of investment property has a close link to future cash flows and share
values, e.g. discounted rental income determines the value of property assets and thus the
company.
‘If we are valuing a profitable quoted company in reality the minimum price that
shareholders will accept will probably be the market capitalization plus an acquisition premium
and not the net asset valuation’. 16
16
18
Types of asset based measures

 Book Value – this will normally be a meaningless figure as it will be based on historical
costs. However, with fair value accounting the book value of many assets and liabilities
will be the fair value and therefore will be relevant for valuation purposes.
 Break-up value – the break-up value of the assets in the business will often be
considerably lower than any other computed value. It normally represents the minimum
price which should be accepted for the sale of a business as a going concern, since if the
income-based valuations give figures lower than the break-up value it is apparent that the
owner would be better off by ceasing to trade and selling off all the assets piecemeal.
 Replacement cost and deprival value: this should provide a measure of the maximum
amount that any purchaser should pay for the whole business, since it represents the total
cost of forming the business from scratch.
However, a major element of any business as a going concern is likely to be the

‘Goodwill’. Since this can only be defined by determining the ‘income – based value of business
less tangible assets’ it may be seen that there is no real way of applying a pure ‘asset-based
value’ to a business – it is always necessary to consider an ‘income-based value’ as well.
Asset Accumulation Method

The asset accumulation method is a widely used asset-based method for large and small
business which determines the business value as the difference between the current value of all
business assets and the current value of all its liabilities.
While the asset accumulation method uses the familiar balance sheet format, the business
value result is very different from the cost-basis historic company ‘book value’. Fair market
value of all business assets , both tangible and intangible is determined.
Next, both recorded a contingent liabilities are valued using the fair market value
standard. The difference between the sum total of the asset value and liability value thus
determined establishes the value of the business.
Some off-balance sheet assets that are included in the asset accumulation valuation are:
19
 Intellectual property items, such as internally developed products and services;

 Key distribution and customer contracts;
 Strategic partnership agreements;
Typical unrecorded liabilities that are included in the valuation are:
 Pending legal judgement;

 Property and income tax obligations;
 Environmental compliance costs.
These may include the nature of the business, for example, whether it is highly seasonal
or vulnerable to changes in fashion or the market. Other factors to consider are the quality of
management and the state of the economy and market conditions.
 Better managed businesses are likely to be more profitable and have better working
capital management than businesses where management is weak.
 If the market or the economy in general is depressed, this is likely to affect companies
adversely and make most or all of their ratios appear worse. The impact may differ
between market sectors.17
Asset Accumulation method is very useful when allocating the purchase price among the
individual business assets, as part of the asset purchase agreement. However , proper application
of the method requires considerable expertise in asset and liability valuation.
This business valuation tool (A.A.M.) wouldn’t give to the potential investors a greater
perspective all by itself without referring to its short-term capabilities of paying-off its debt; and
the key measure for a larger perspective over the valuation process can be highlighted by the
working capital, which represents a key liquidity measure of business solvency.
Working Capital represents the difference between the current assets of the business and
its current liabilities.
17
ACCA – paper P2 – CORPORATE REPORTING – Chapter 23 – ‘Assessing performance and position’ ;
20
Working capital, also, represents the funds required to conduct daily business operations.
It shows what readily available resources the business has at its disposal in order to meet the
obligations coming due in the short term.
If a company knows that it will need the funds in three days (or weeks or months), it
simply invests them for just that period at the best rate available with safety. The solution is to
match the maturity of the investment with the period for which the funds are surplus. However,
there are a number of factors to consider18:
 The exact duration of the surplus period is not always known. It will be known if the cash
is needed to meet a loan instalment, a large tax payment or a dividend. It will not be
known if the need is unidentified, or depends on the built-up of inventory, the progress of
construction work, or the hammering out of an acquisition deal.
 Expected future trends in interest rates affect the maturity of investments.
 Bridging finance may be available to bridge the gap between the time when the cash is
needed and the subsequent date on which the investment matures.
 An investment may not need to be held to maturity, if either an earlier withdrawal is
permitted by the terms of the instrument without excessive penalty, or there is a
secondary market and its disposal in that market causes no excessive loss.
 A good example of such an investment is a certificate of deposit (C.D.), where the
investors ‘lends’ the bank a stated amount for a stated period, usually between one and
six months. As evidence of the debt and its promise to pay interest, the bank gives the
investor a C.D.; there is an active market for C.D.s issued by the commercial banks and
turning a C.D. into cash is easy and cheap.
The ratio of the current assets divided by current liabilities is known as the current ratio.
Accounting for adequate working capital is an essential element of buying businesses.

For many businesses, the working capital needs change throughout the year. As a business buyer
18
ACCA- paper F9- FINANCIAL MANAGEMENT- Chapter 10- ‘Working capital management – cash and funding
strategies’ ;
21
you need to determine what these seasonal fluctuations are and provide for sufficient working
capital at all times.19
19
Richard Loth, article : ‘The Working Capital Position ‘ july 2012, / www.investopedia.com/- financial online
portal;
22
Chapter 2
CASE STUDY at OMV PETROM

2.1. COMPANY PRESENTATION AND VALUATION
. BACKGROUND
OMV Petrom is a Romanian oil company, the largest corporation in Romania, which
according to ‘Ziarul Financiar ‘ has a 2013 market value around 5.708 million of RON. Also,
Petrom represents the largest gas and oil producer in Eastern Europe with activities in the
business segments of Exploration and Production, Refining and Petrochemicals, Marketing, Gas
and Energy.
In 2013, Petrom reviewed its business strategy to position themselves for long-term
growth, in the context of complex regional and international developments and the yield
achieved during this year has demonstrated the efficiency of their strategy, which allow them to
do massive investments, over 1 € billion , in the operational activity.
Its Strategy-2021- reconfirms the previous strategic directions, matches the OMV Group
Strategy and addresses the needs of the Romanian energy sector.
Petrom vision is to remain the leading regional, integrated oil and gas company with
sustainable performance needed to support potential upstream growth in the neighbouring of
Black Sea region.
To this end, its efforts will continue to focus on maximizing the current E&P portofolio
value and positioning for growth, on enhancing the value of equity gas and on optimizing the
integrated equity oil.
Regarding to the valuation process, this case study is assessing Petrom’s business using
the following three valuation methods:
23
2.2. RESULTS
Petrom’s 2013 key financial data :
Million RON
EQUITY 5,664
SALES 24,285
NET INCOME 4,821
CASH FLOW FROM OPERATING ACTIVITIES 8,048
EBIT 5,957
INVESTMENTS 5,303
EMPLOYEES AT THE END OF PERIOD 19,619
2.2.1. Company valuation using INCOME/EARNINGS –based method
Stock variation and EPS
2011 2012 2013

EPS
(RON/share) 0.0663 0.0698 0.0851
Year's low
(RON) 0.2750 0.2900 0.4098
Year's high
(RON) 0.4500 0.4327 0.4784
Year's end
(RON) 0.2900 0.4281 0.4698
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠ℎ𝑎𝑟𝑒 𝑌𝑒𝑎𝑟 ′ 𝑠 ℎ𝑖𝑔ℎ+𝑌𝑒𝑎𝑟 ′ 𝑠 𝑙𝑜𝑤 0.4784+0.4098

= = =0.4441 RON/share;
𝑝𝑟𝑖𝑐𝑒 2013
2 2
Price/Earnings Ratio method
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒔𝒉𝒂𝒓𝒆 𝒑𝒓𝒊𝒄𝒆 𝟎.𝟒𝟒𝟒𝟏

𝑷𝒓𝒊𝒄𝒆/𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔2013 = 𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
= 𝟎.𝟎𝟖𝟓𝟏
= 5.22
24
In order to find a suitable aggregate value of the entire Petrom OMV Group a useful tool
might be to calculate its Market capitalization by multiplying the average share price with the
present number of Petroms’ shares:
Group market capitalization = Average share price X Number of shares
for 2013 = 0.4441 RON/share X 56,644,108,335
= 25,156,648,511.5 mn. RON
= 25,156 mn. RON
= 5,590 mn. EUR.
Result interpretation
If Petrom’s stocks are trading at 0.4441 RON/stock and the earnings per share for most
recent 12-month period is 0.0851 RON, then Petrom’s stock has a P-E ratio of 5 (adjusted); with
other words, the purchaser of the stock is paying 5 RON for every RON of earnings.
Earnings per share is the basic measure of a company’s performance from an ordinary
shareholder’s point of view. It is the amount of profit , in cents, attributable to each ordinary
share.
If this P-E ratio is compared to the P-E ratio of the industry the company is in:
Petrom OMV current P-E ratio Oil/Gas Industry (Integrated) P-E ratio
5.22 > 10.97 20
results that either the stock is undervalued, or the company’s earnings are thought to be in
decline.
Investors are willing to buy shares in the company at 5.22 times last year’s earnings
compared with the previous year’s position when they were willing to pay 5.18 times the
earnings. This increase may be because the company is expected to grow as much as in the
20
S&P Capital IQ, Bloomberg and the Fed; date of analysis : January 2014;
25
previous year. The industry average PE increased year-on-year from 10.21 to 10.97, which may
suggest that this company is expected to generate greater growth or carries more risk than the
industry average.
Alternatively, current earnings may be substantially above Petrom’s historic trends or the
company may have profited from selling assets.
2.2.2 Company valuation using INCOME-based method:

‘In terms of tools and techniques, Petrom follows the best international practices in risk
management and uses stochastic quantitative models to measure the potential loss associated
with the company’s risk portofolio under a 95% confidence level and a three-year horizon.
All risks are analysed based on their causes, consequences, historical trends, volatilities
and cash flow potential impact.’21
Business risk free rate22 = 1− Confidence level associated with company’s risk portofolio
= 1− 0.95 = 0.05 = 5% ;
The discount rate captures the business risk and represents the required rate of return to
make a business worthwhile, as an investment decision.
[Discount Rate > Business Risk Rate] ↔[11% > 5%]
* assuming a 11% real return rate for fund providers in order to compensate both inflation and
the business risk;
Romanian inflation rate evolution -2010-2013- 23
2010(%) 2011(%) 2012(%) 2013(%)
Inflation rate 6.09 5.79 3.33 3.98
Average inflation 4.79
21
OMV Petrom’s 2013 Integrated Risk Management System Report;
22
Aswath Damodaran, ‘What is the Free-risk rate? A search for the Basic Building Block’ , Stern School of Business,
New York University, December 2008;
23
National Institute of Statistics and Economic Studies;
26
The real rate and money rate returns are linked by the formula 24:
r = money rate;
1+𝑖
1+ r = ; where: h = inflation ;
1+ℎ
i = real rate;
1+i 1+𝑖
1+ 11%= ↔1.11= ↔ 1+ i=1.11×1.0479 ↔ i=0.1631↔i=16.31%
1+0.0479 1.0479
Discounted Cash Flow method:
The impact of inflation over Petrom’s real cash flows (2010-2013) table 1
TIMING REAL/CASH INFLATION MONEY DISCOUNT PRESENT

FLOW FACTOR CASH FLOW FACTOR VALUE
(a) mn. RON (b) (a)x(b) mn. RON @ 16.31% mn. RON
2010 4,630 1 4,630 1.000 4,630

2011 6,442 1+0,0479 6,750 0.859 (6)* 5,790
2012 7,185 (1+0,0479)2 7,890 0.739 5,830
2013 8,048 (1+0,0479)3 9,260 0.635 5.880
NET PRESENT VALUE 22,130
25
Present value of 1=(1+r)-n , where: r = discount rate;
n = number of periods until payment.
1/1.1631 = 0.859;
1/1.16312 = 1/1.3528 = 0.739; 1/1.16313 = 1/1.5734 = 0.635;
24
ACCA – paper F9 – FINANCIAL MANAGEMENT- Chapter 4 – ‘Investment appraisal – further aspects of Discounted
Cash Flows.
25
27
At actual data, Petrom OMV business value using the Discounted Cash-Flows as a
business valuation tool is highlighted at approximately 22,130 mn RON; The above technique
considers the time value of money, and because of that the value obtained (22,130 mn RON)
may vary in a real professional valuation expertise mainly due to the impact of interest, inflation
and risk over time.
Result interpretation:
For Petrom, this income approach valuation tool determines the value of the business
based on its ability to generate desired economic benefits for the owners;
Furthermore, for achieving this 4-years-NPV result, mn. RON 22,130, the largest
contribution was provided by the 2013-real-cash-flows, which represents 36.36 % of the NPV,
including the influence of the last 4 years inflation.
In other words, this positive NPV is an indication of the surplus funds available to the
investor now as a result of continuing the investment policy.
Overall, this valuation tool shows a desirable NPV, which can be understood as a positive
outcome if the investment appraisal is related to the outflows that Petrom is generating; and ,
excepting the 2010 financial year, for the last years the cash flow from operating activities
exceeded the company’s investments – which reflects the importance of establishing the
investment policy by taking into account the business stream of future economic benefits
discounted to their present value.
28
Figure no. 2 – 2010-2013 Variation of Cash Flow from operating activities and Investments
Cash Flow evolution related to the investment

policy in the last 4 years
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2010 2011 2012 2013
C.F. from operating
4,630 6,442 7,185 8,048
activities
investments 4,863 4,803 4,930 5,303
2.2.3. Company valuation using ASSET-based method
The 3-rd valuation method is a mixed tool which involves the determination of fair value
of all assets and liabilities adjusted with the current value of the working capital business in order
to assess the importance of the covering the short-term obligations.
This type of approach is valuing the business by focusing on Petrom’s net asset value, or
the fair-market value of its total assets minus total liabilities.
29
Petrom’s Working Capital adjusted (+/-) with asset accumulation policy:

mn. RON
(+) CURRENT ASSETS 5,487

(-) CURRENT LIABILITIES (5,167)
(=) WORKING CAPITAL (3) 320
(-) PENDING LEGAL JUDGEMENTS- a fine imposed by the Romanian
Competition Council as a result of the antitrust investigation (503)
(+) KEY DISTRIBUTION AND CUSTOMER CONTRACTS- a farm-out
agreement with REPSOL (Argentina) 225
(-) PROPERTY AND INCOME TAX OBLIGATIONS –
Deferred Income (107)
Provisions for taxes to be paid to Romanian state (235)
Provisions for late payment interests (2009, 2010) (209)
(+) STRATEGIC PARTNERSHIP AGREEMENTS- Jointly controlled 504
assets
(-) ENVIRONMENTAL COMPLIANCE COSTS – Environmental (232)
provision
(=) ADJUSTED NET ASSETS ACCUMULATION FOR 2013 Y/E (9) (557)
(3)+(9) PETROM’s WORKING CAPITAL ADJUSTED(+/-) WITH NET
ASSETS ACCUMULATED (237)
A reasonable type of asset-based measurement is represented by the BOOK-VALUE of

assets and liabilities, which is given by historic cost value, that can be easily managed as the fair
value.
NET ASSETS = TOTAL ASSETS – TOTAL LIABILITIES
(mn RON) = TOTAL ASSETS – (EQUITY + NON-CURRENT LIABILITIES) *
= 40,046 – (26,641 + 8,237)
= 5,168 mn. RON
*(data gathered from Petroms’ 2013 simplified balance-sheet).
30
Result interpretation:
The third valuation tool reflects the influence of off-balance sheet assets and liabilities
over the Petrom’s working capital in 2013 financial year.
The aggregate value obtained (5,168 mn RON), basically represents what it would cost to
recreate the business. On the other hand, this method is not interpretation-free due to the terms of
deciding which of the company’s assets and liabilities to include in the valuation, and how to
measure the worth of each
Positive Working Capital, (mn. 320 RON), means the fact that the business currently is
able to pay-off its short-term liabilities with its current assets; Petrom’s currently 6.19 %
financial excess of the operating liquidity available to business can be a signal that the company
might be able to expand its operations in the near future.
Total investments for Petrom in 201 are represented by mn. 5,303 RON even the actual
debt that the investor owes (mn. 237 RON) will be offsetted by the positive effect of the assets
accumulation policy which can be cash assets or real property.
A review over the customer contract made by a farm-out agreement between Petrom and
Repsol (a global integrated energy company) reveals the best example of real property asset
accumulation which is represented by a € 50 mn. investment in the next two years.
Overall, the asset accumulation valuation method, at a current debt rate of 4.47 % from
total current investments activities represents Petrom’s long-term vision of increasing portfolio
values, net worth and savings account balances, as cash is saved or invested and then grows
through interest earnings and investment gains.
31
2.3. Sensitivity analysis

Sensitivity analysis typically involves posing ‘what-if?’ questions; for example, what if
demand fell by 10% compared to our original forecasts ?
Would the project still be viable?
Ideally, we want to know how much demand could fall before the project should be
rejected or, equivalently, the breakeven demand that gives an NPV of zero.
We could then assess the likelihood of forecast demand being that low. 26
Using the Net Present Value method, Present Values are calculated by discounting cash
flows at a given cost of capital, and the difference between the Present Value of costs and the
Present Value of benefits is the Net Present Value. In contrast, the Internal Rate of Return
method of Discounted Cash Flow analysis is to calculate the exact Discounted Cash Flow rate of
return that the project is expected to achieve.
If an investment has a positive Net Present Value, it means it is earning more than the
cost of capital. If the Net Present Value is negative, it is earning less than the cost of capital. This
means that if the Net Present Value is zero, it will be earning exactly the cost of capital.
Conversely, the percentage return on the investment must be the rate of discount or cost
of capital at which the Net Present Value equals zero. This rate of return is called the Internal
Rate of return, or the Discounted Cash Flow yield and if it is higher than the target rate of return
then the project is financially worth undertaking.
IRR = L + [𝑁𝐿−𝑁𝐻
𝑁𝐿
] X (H – L) ;
L = Lower rate of interest; NL = NPV at lower rate of interest;
H = higher rate of interest; NH = NPV at a higher rate of interest.
26
ACCA – paper F9 – FINANCIAL MANAGEMENT – Chapter 6 – ‘Investment appraisal under uncertainty’ ;
32
Advantages and disadvantages of sensitivity analaysis
Strengths of sensitivity analysis:

 No complicated theory to understand;
 Information will be presented to management in a form which facilitates subjective
judgement to decide the likelihood of the various possible outcomes considered;
 Identifies areas which are crucial to the success of the project. If the project is chosen,
those areas can be carefully monitored.
 Indicates just how critical are some of the forecasts which are considered to be uncertain.
Weaknesses of sensitivity analysis :

 It assumes that changes to variables can be made independently of other variables. This is
unlikely. If material prices went up the firm would probably increase selling price at the
same time and there would be little effect on NPV. A technique called SIMULATION
allows us to change more than one variable at a time.
 It only identifies how for a variable needs to change. It does not look at the probability of
such a change.
In the above analysis, sales volume appears to be the most crucial variable, but if the firm
were facing volatile raw material markets a 65% change in raw material prices would be
far more likely than a 29% change in sales volume.
 It is not an optimizing technique. It provides information on the basis of which decision
can be made. It does not point directly to the correct decision. 27
27
ACCA – paper F9 – FINANCIAL MANAGEMENT – Chapter 6 – ‘Investment appraisal under uncertainty’ ;
33
Sensitivity analysis case scenario:

Applying sensitivity analysis for the three company values obtained through business
valuation methods, often involves ‘what-if?’ cases:
Scenario 1:
What if ? -cases for 2014 financial year:
A). ‘What would be the value of Petrom OMV, using the market capitalization value if
the average share price will decrease with 10% of their actual value?’
B). ‘Which will be the impact over the Net Present Value of Petrom OMV for 2014, if
the average inflation rate will increase with 10%, and, in the same time, the required return will
also increase with 10%?‘
C). ‘What would be the value of the net assets for Petrom OMV in 2014 if the value of
its equity and non-current liabilities will increase with 10% over the last years’ value?’
A). Average share price2014 = Average share price 2013 x 90%
= 0.4441 Ron/ share x 0.9
= 0.3996 Ron/ share;
* Assuming there will be no changes in the number of shares for the next year;
Group market capitalization2014 = Average share price2014 x Number of shares
= 0.3996 Ron/ share x 56,644,108,335 shares
= 22,634,985,690.6 Ron
= 22,635 mn. Ron.
On a percentage point of view, a 10% decrease in the average share price, will lead to an
11.13% decrease of the aggregate market capitalization value for the Group, from 25,156 mn
Ron in 2013 to 22,635 mn Ron in 2014.
B). Average inflation rate2014 = Average inflation rate2013 x 110%
= 4.79% x 1.1
= 5.269% = 0.05269;
34
Required return2014 = Required return2013 x 110%
= 11% x 1.1
= 12.1%
With the modified inputs above, the real rate of cash-flows will be:
r = money rate;
1+𝑖
1+ r = ; where: h = inflation ;
1+ℎ
i = real rate;
1+𝑖 1+𝑖
1+ 12.1% = ↔ 1.121 = ↔ 1+i = 1.121 x 1.05269
1+0.05269 1.05269
1+ i = 1.121 x 1.05269 ↔ 1+i = 1.1803 ↔ i = 18.03%;
2014 Net Present Value table 2
TIMING REAL/CASH INFLATION MONEY DISCOUNT PRESENT

FLOW FACTOR CASH FLOW FACTOR VALUE
(a) mn. RON (b) (a)x(b) mn. RON @ 18.03% mn. RON
0 4,630 1 4,630 1.000 4,630

1 6,442 1+0,05269 6,781 0.847 5,743
2 7,185 (1+0,05269)2 7,957 0.717 5,705
3 8,048 (1+0,05269)3 9,384 0.608 5.705
NET PRESENT VALUE 21,783
With other words, a possible increase with 10% in the average inflation rate and with
10% in the required return will lead to a 1.57% decrease in the Net Present Value of the
company, from 22,130mn Ron in 2013, to 21,783 mn Ron in 2014.
35
C). Equity2014 = Equity2013 x 110%
= 26,641 mn Ron x 1.1
= 29,305 mn Ron;
Non-current liabilities2014 = Non-current liabilities2013 x 110%
= 8,237 mn Ron x 1.1
= 9,060 mn Ron;
With these estimates, in 2014, the net assets might be:
Net assets2014 = Total assets – (Equity2014 – Non-current liabilities2014)
= 40,046 mn Ron – (29,305 mn Ron + 9,060 mn Ron)
= 40,046 mn Ron – 38,365 mn Ron
= 1,681 mn Ron.
With this scenario, a 10% increase in the value of Petrom OMV’s 2013 Equity and Non-
current liabilities will lead to a 2014 Net Assets value decreased with 67.47% from 5,168 mn
Ron in 2013 to 1.681 mn Ron in 2014.
Scenario 2:
 Petrom OMV is considering investing 220 millions RON in crude OilField in order to
redevelop 150 new oil-derricks;
Estimates :
 Sales of the products are expected to continue for three (3) years, at the end of which the
derricks will have a scrap value of 35 million RON;
 Sales revenue of 400 million RON per annum, will be generated at a variable cost of 180
million RON.
 Annual fixed costs will increase by 18 million RON;
 Assuming that all cash flows occur at annual intervals and Petrom OMV has a cost of
capital of 15%.
36
NPV Calculation
TIME NARRATIVE CASH 15 % DISCOUNT PRESENT

FLOW RATE VALUE (mn.
(mn. RON) RON)
0 Derricks (220) 1.000 (220)
1-3 Revenue 400 2.283 913
1-3 Variable costs (180) 2.283 (410)
1-3 Fixed costs (18) 2.283 (41)
3 Scrap value 35 0.658 23
NPV 265
The derricks-investment project, on the basis of these estimates, should be accepted.
Calculating sensitivity :
(i) Initial investment
For the decision to change, the NPV must fall by 265 million RON. For this to occur, the
cost of the derricks must rise by 265 million RON.
200
This is a rise of: x 100 = 75.47 = 75 % ;
265
(ii) Scrap value
If the Net Present Value is o fall by 265 million RON, the Present Value of scrap proceeds
must fall by 265 million RON. The Present Value of scrap proceeds is currently 23 million RON.
265
It must fall by x 100 = 11.52 = 11 %;
23
(iii) Selling price
If sales price varies, sales revenue will vary (assuming no effect on demand). If the Net
Present Value of the project is to fall by 265 million RON, the selling price must fall by:
265
x 100 = 29.02 = 29 % ;
913
37
(iv) Unit variable cost
The project’s Net Present Value must fall by 265 million RON, therefore the Present Value
of the variable costs must rise by 265 million RON. Since Present Value of variable costs is 410
million RON, a rise of 265 million RON is an increase of:
265
x 100 = 37.32 = 37 %;
410
(v) Annual fixed costs
Since the Present Value of fixed costs is 41 million RON, a rise of 265 million RON is an
increase of:
265
x 100 = 646 % ;
41
(vi) Sales volume
If sales volume falls, revenue and variable costs fall (contribution falls). If the Net Present
Value is to fall by 265 million RON, volume must fall by:
265
x 100 = 52.68 %;
913−410
(vii) Cost of capital
If Net Present Value is to fall, cost of capital must rise. The figure which the cost of capital
must rise to, that gives an Net Present Value of zero, is the project’s Internal Rate of Return.
To find the Internal Rate of Return, which is probably not much above 15 %, the Net Present
Value at 20 % can be found using the summarized cash flows.
Net Present Value = -220 + [202 x 2.106] + [35 x 0.579] =
(million RON) = -220 + 425 +20

= 225 ;
38
The Internal Rate of Return is therefore a little closes to 20 % than 15 %,
265
Internal Rate of Return ≈ 15 + x (20 – 15) ≈ 17.70 % ;
265+225
2.4. Comparison of Results

In 2013, Petrom has achieved an operating profit (EBIT) good, 5.958 million, up 5%
from the previous year, mainly due to higher contribution of Refining and strict cost
management, partially offset by lower margins.
In Exploration and Production, for the first time since privatization, the Group recorded a
slight increase in hydrocarbon production in 2013 in Romania, while at Group level, production
was largely stable. Natural decline of mature hydrocarbon deposits was offset by good results of
optimization initiatives, which included overhauling activities and drilling new wells.
In 2013, we maintained our status as the largest investor in the energy sector in Romania,
with a total investment of 5,303 million, 8% higher than in 2012, mainly devoted to projects in
E&P. In E&P EBIT increased by 1% compared to 2012, to 5,529 million, due to the nature of
special items costs lower. The result of 2012 included special items totaling (287) million,
mainly related to a dispute in Kazakhstan bad debt.
Petrom is an integrated oil and gas. Since the oil produced by the E&P is mostly processed in
Petrobrazi, R&M has the largest share in the Group's consolidated sales.
Consolidated sales revenues decreased by 8% compared to 2012, reaching 24,185 million,
mainly due to lower sales of oil and oil products, partially offset by increased sales of electricity
in 2013.
The net financial result shows a loss of (259) million, improved from last year (2012:
loss of (836) million, it was negatively influenced by the nature of special items of expenditure
in the amount of (209) million, representing interest on late pretense after receiving preliminary
results of the tax audit for the years 2009 and 2010 the fund made in 2012 Petrom and the effect
of discounting the debts.
39
In 2013, income tax expense decreased slightly compared to 2012, to 875 million,
influenced positively related deferred tax income in subsidiaries in Kazakhstan. Consequently,
the effective rate of corporation tax at Group level decreased to 15% (2012: 18%, since the year
2012 was affected by the expense resulting from tax audits).
Investments increased to the value of 5,303 million (2012: 4,930 million) as a result of
higher investments in E&P segment, partially offset by lower investment made G&E and R&M.
Investment in E&P, in the amount of 4,401 million (2012: 3,753 million) represented 83% of the
total recorded in 2013 and were predominantly focused on development drilling projects
integrated redevelopment works and subsurface operations, surface facilities and related
investments TOTEA DEEP project.
Total assets increased slightly with 1.902 million RON, to 40.047 million RON. Increase
of tangible and intangible assets with the amount of 1,995 million is the main cause of the
increase in net fixed assets of 1,783 million, up to 34.560 million. Tangible and intangible inputs
(5.408 million RON) exceeded the total amount of depreciation and impairments and disposals
of assets, the amount of 1,995 million RON. Share of tangible and intangible assets to total assets
amounted to 79% (2012: 77%).
Gearing ratio. Petrom Group's net debt decreased significantly with 332 million RON,
compared with 1.711 million RON at the end of 2012, as cash inflows from operating activities
exceeded cash outflows for investments and financing. Consequently, on 31 December 2013, the
gearing ratio continued to decline to 1.2 % from 7.3% at the end of December 2012.
Cash flows. Group's cash flow statement is prepared using the indirect method.
Cash flow from operating activities increased by 863 million RON or 12% compared to 2012,
reaching 8.048 million RON. Reconciliation of profit before taxation to cash flow generated
from operating activities (before changes in net current assets) resulted in a net upward
adjustment of 2,426 million RON in 2013 (2012 : 2,352 million RON) .
While depreciation adjustments and reversals of impairment of fixed assets added 3.355 million
RON (2012 : 2,852 million ) , net changes in provisions (including provisions for
decommissioning and restoration obligations and other provisions for risks and charges)
contributed to a decrease of 60 million RON( 2012: decrease of 227 million RON) of cash flows.
Disposals of fixed assets and other non-cash adjustments resulted in an increase of 101 million
RON (2012: increase by 781 million RON).
40
Net interest and tax paid generated a cash outflow of 969 million RON (2012: cash
outflow amounting to 1.053 million RON).
In 2013, net working capital generated a cash outflow of 77 million (2012: inflow £ 7 million).
In terms of cash flow, inventories decreased by 146 million RON (2012: increase of 25 million
RON), receivables decreased by 340 million RON (2012: increase of 162 million RON) and
liabilities decreased by 562 million RON (2012 rose to 194 million RON) .
Dividend. The strong 2013 results and healthy financial position enable Petrom to invest
in the company’s future sustainable growth and also to propose to the General Meeting of
Shareholders, the payment of a dividend of RON 0.028 per share, corresponding to a payout ratio
of 40% of the net profit.
The above case study shows three different types of business valuation approaches; if the
income-based method and cash flow-based method can be seen, somehow, having closed values,
with the Net Present Value lower with just 10% than the value of market capitalization, it can’t
be said the same thing about the value of the Petroms’ net assets.
The main factor which contributed to the actual value of Petroms’ market capitalization is
represented by the increase in the shares price with 38.27% from 0,2900 RON/share in 2011 to
0,4281 RON/ share in 2012, and with 8,89% from 0,4281 RON/share in 2012 to 0,4698
RON/share in 2013.
Related to the Net Present Value achieved, the main influence over Petrom’s yearly cash-
flows can be attributed to the constant rate of increasing its overall cash-flows from operating
activity during the last four years, from 4,630 mn. RON in 2010 to 8,048 mn. RON in 2013.
The output of the third business valuation can be best described by the elements that have
contributed to the value of Petrom’s net assets:
 The share capital and the reserves represents almost 76.4% of total liabilities, and the rest
of 23.6% is attributed to the non-current liabilities, whose main part, of 70.2% is
represented by Provisions for decommissioning and restoration obligations.
 Another main contributor to the Petroms’ net assets is the value of non-current assets
which represents 86.3% of total assets; a part of this percentage is attributed to the
Tangible assets, property, plant and equipment, which is 88.7% of non-current assets;
 The last major elements involved in computing Petroms’ net assets are the current assets
which represents 13.6% of total assets, and a large amount of its value is represented by
the Inventories and Trade Receivables which forms 66.5% of current assets.
41
Chapter 3
CONCLUSIONS
The process of business valuation can be best described as the ‘generally accepted ways
of determining the value of a business and professional practices’. There are several approaches
used for business valuation. Each approach serves as a foundation for a group of methods used to
determine the business value.
The Income Approach methods determine the value of a business based on its ability to
generate desired economic benefit for the owners. The key objective of the income based
methods is to determine the business value as a function of the economic benefit.
For example, Petrom’s 2013 net income amounted a 22 % slightly increase up to 4.824
milion RON, which is a remarkable improvement of its managerial up-to-date international
practices.
But there are various parties whose viewpoints best describes the real worth of a
company.
A negative fact for Petrom’s 2013 valuation is that consolidated sales revenues decreased
by 8%, compared to 2012, mainly due to the decrease of the sales of oil and oil products,
partially offsetted by increased sales of electricity.
As a counterbalance for this decreased sales revenues, the users of Petrom’s financial
data can identify the Group’s investment policy and the cash flow from operating activities
increased with 8%, respectively 12% related to last year, which is an encouraging factor for
further expansion and development.
There are other positive signs apart from falling turnover (from 26.258 million RON to
24.185 million RON) and increasing earnings per share (from 0.0698 RON to 0.0851 RON). The
shareholders will not be concerned about experiencing a capital gain in 2013.
Related to the investment decisions, dividend decisions and financing decisions have
often been called the decision triangle of financial management. The study of financial
42
management is often divided up in accordance with these three decision areas. However, they are
not independent decisions, but closely connected.
For example, a Petrom’s potential decision to increase dividends might lead to a

reduction in retained earnings and hence a greater need for external finance in order to meet the
requirements of proposed capital investment projects. Similarly, a decision to increase capital
investment spending will increase the need for financing, which could be met in part by reducing
dividends.
The market value of Petrom (26.611 million RON), and therefore the wealth of
shareholders were shown to be maximized when the company implemented its optimum
investment policy, which was to invest in all projects with a positive Net Present Value.
The investment decision was therefore shown to be theoretically important with respect
to the market value of the company, while the dividend decision was not relevant.
Related to the economic expectations, if Petrom expects buoyant economic conditions

and increasing profitability in the future, it will be more prepared to take on fixed interest debt
commitments than if it believes difficult trading conditions lie ahead.
For Petrom, in 2013, the most important gain achieved, related to the Group valuation,
was the market capitalization, from 24,249 million RON to 26,611 million RON, which
represent an approximately 9% increase in its aggregate value.
A straight recommendation for Petrom’s investment policy of its own surplus funds is
about combinations of non-divisible projects in order to find the combination giving rise to the
highest net present value.
The net present value analysis has been based on the company’s average cost of capital
(17.70%) and it is unlikely that surplus funds can be invested in order to earn a return as high as
this.
Investment of surplus funds in, for example, the money markets would therefore be an
investment project that would be rejected as having a negative net present value, or an internal
43
rate of return less than the company’s average cost of capital if using Internal rate of return to
assess investments projects.
However, it is good working capital management to ensure that liquid funds are invested
to earn the highest available return, subject to any risk constraints, in order to increase overall
profitability.
As stated earlier, an appropriate value only can be decided (or often negotiated if the
valuation is for sale & purchase transaction), as there is no scientific way of accurately valuing a
company. Hence it is often said that valuation is an art and not a science.
44
References
I ACCA – paper F9 – FINANCIAL MANAGEMENT

1) Chapter 3 ‘Discounted Cash Flow technique’
2) Chapter 4 ‘Investment appraisal – further aspects of Discounted Cash Flow’
3) Chapter 6 ‘Investment appraisal under uncertainty’
4) Chapter 10 ‘Working Capital management – cash and funding strategies’
5) Chapter 20 ‘Business valuations and market efficiency’
II ACCA –paper P2 – CORPORATE REPORTING

1) Chapter 3 ‘Discounted Cash –Flow technique’
2) Chapter 23 ‘Assessing performance and position’
III ACCA – paper P3 – BUSINESS ANALYSIS

Chapter 9 ‘Business process change’
IV Aswath Damodaran, – ‘Discounted Cash flow Valuation: - The Inputs’,

Stern School of Business at New York University.
V Aswath Damodaran, ‘What is the free-risk rate? A search for the Basic Building Block’,
Stern School of Business at New York University, December 2008.
ARTICLES :
VI Richard Loth
1) ‘The Working Capital Position’ , july, 2012;
2) ‘Investment Valuation Ratios : Price/ Earnings Ratio’ , 2012;
3) ‘Analyse Cash flow – The Easy Way’ ,November 2012;
VII Kevin Garrett – ‘Business Valuations’ – ACCA freelance lecturer and writer;
45
OTHER SOURCES
VIII 1) S&P Capital IQ, Bloomberg and the Fed; date of analysis: January 2014;
2) OMV Petrom’s 2013 Integrated Risk Management System Report;
3) National Institute of Statistics and Economic Studies;
IX ONLINE SOURCES
1) www.petrom.ro
2) www.insse.ro
3) www.investopedia.com
4) www.valuadder.com
5) www.accaglobal.com
46
APPENDICES:
1) 2009-2013 NET income attributable to stockloders (RON):
47
2) 2009- 2013 - Earnings per Share;
48
3) 2009-2013 Cash flow from operating activities (RON mn.)
49
4) 2013 Sharehoders structure:
Shareholder structure Petrom OMV S.A. (%)

OMV Aktiengesellschaft (O.M.V.) 51.01
Ministry of Economy, Trade and Business Environment (M.E.C.M.A.) 20.64
Property Fund (P.F.) 20.11
European Bank for Reconstruction and Development (E.B.R.D.) 1.62
Free float (over 500 institutional investors and over 463,000 private individuals ) (F.F) 6.62
100
50

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BUSINESS VALUATION AND CASE STUDY at PETROM OMV

BUCHAREST UNIVERSITY OF ECONOMIC STUDIES

FACULTY OF ACCOUNTING AND MANAGEMENT

BUCHAREST UNIVERSITY OF ECONOMIC STUDIES

FACULTY OF ACCOUNTING AND MANAGEMENT

BUSINESS VALUATION AND CASE

THE THEORY OF BUSINESS VALUATION

1.1. THE NEED FOR BUSINESS VALUATION

The real worth of a company

Valuation: an art and not a science

Information requirements for valuation exercises

 Financial statements (including statements of financial position and statement of profit or

 Details of existing contracts (e.g. leases);

The relevance of the valuation methods used must also be considered.

A valuation based on present value of future cash flows is considered particularly

Business valuations and market

Approaches and Valuing debt Market efficiency

Irredeemable Preference Inefficient

Asset based Income/Earnings Cash-flow

Book NRV Replacement Price Earnings DVM DCF

Valuing business and financial assets

 to establish terms of takeovers and mergers, etc;

 Income/Earnings – based on the returns earned by the company;

1.2. BUSINESS VALUATION METHODS

1.2.1. Income / Earnings –based method of Business Valuations

Price /Earnings ratio method:

𝐏𝐫𝐢𝐜𝐞 𝐒𝐭𝐨𝐜𝐤 𝐩𝐞𝐫 𝐏𝐫𝐢𝐜𝐞 𝐒𝐡𝐚𝐫𝐞

Value of company = Total earnings x Price/Earnings ratio;

Problems with the PE ratio valuation:

Adjustment 1 is a private company as its shares may be less liquid;

For example, a high PE ratio may indicate:

Similarly, a low PE ratio may indicate:

It would be unwise to value a company on freakishly high earnings. 7

1.2.2. Cash –flow –based method of Business Valuations

Discounted Cash Flow Basis

Valuing a Business based on Cash Flow and Risk

 Business cash Flow stream;

Advantages and disadvantages of NPV

However, there are some potential NPV drawbacks:

 It is difficult to explain to managers. To understand the meaning of the NPV calculated

Steps in Cash Flow Estimation

 Consider how much the firm invested to create future growth:

1.2.3. Asset – based method of Business Valuation

Types of asset-based measures15

MEASURES STRENGTHS WEAKNESSES

When asset based methods are useful

To set a minimum price in a takeover bid

To value property investment companies

Types of asset based measures

However, a major element of any business as a going concern is likely to be the

Asset Accumulation Method

 Intellectual property items, such as internally developed products and services;

Typical unrecorded liabilities that are included in the valuation are:

 Pending legal judgement;

Accounting for adequate working capital is an essential element of buying businesses.

CASE STUDY at OMV PETROM

2.2.1. Company valuation using INCOME/EARNINGS –based method

Stock variation and EPS

2011 2012 2013

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠ℎ𝑎𝑟𝑒 𝑌𝑒𝑎𝑟 ′ 𝑠 ℎ𝑖𝑔ℎ+𝑌𝑒𝑎𝑟 ′ 𝑠 𝑙𝑜𝑤 0.4784+0.4098

Price/Earnings Ratio method

𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒔𝒉𝒂𝒓𝒆 𝒑𝒓𝒊𝒄𝒆 𝟎.𝟒𝟒𝟒𝟏