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# Investment Analysis and Recommendation - BP

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Please examine the mix of debt and equity that British Petroleum (BP) uses. After finding this information:

• Compare this to an industry average or Dutch Shell. What are the differences?
• Based on what you know about BP, do these differences seem appropriate?
• Relate BP's capital structure choices to the appropriate capital structure theory (ies).

BP Annual Report and Form 20-F 2012:
http://www.bp.com/content/dam/bp/pdf/investors/BP_Annual_Report_and_Form_20F_2012.pdf

Royal Dutch Shell plc annual report of 2012:

#### Solution Preview

BP - Capital Structure

Gross debt at 31 December 2012 was \$48.8 billion compared with \$44.2 billion at 31 December 2011. Net debt was \$27.5 billion at 31 December 2012, leaving BP's gearing (net debt ratio) at 18.7%.
BP's shareholders' equity at 31 December 2012 was \$118,414 million.
Net Debt + Net Equity = \$167.214 billion
% of Debt = 48.8/167.214 = 29.18%
% of Equity = 118.414/167.214 = 70.82%
Debt-Equity ratio = Total Debt/Total BP ...

#### Solution Summary

The solution discusses the investment analysis and recommendation.

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## Investment Analysis and Recommendation - BP Oil

Please calculate the weights (proportions) of debt and equity for British Petroleum (BP). For equity you can use the market value of stock (number of shares times the current stock price). For debt, you can use the book value of long-term debt (from the balance sheet). While market values of debt are "better," they are rather difficult to obtain. Estimate the required rate of return on debt for BP.

The following are three possible approaches:

a) You can use the credit rating provided by Standard & Poor's or Moody's. Use the ratings to find current yields above risk-free rates.
b) Go to FINRA Market Data. This will give the yield to maturity for EACH bond. You need one measure of the cost of debt, so you will have to figure out an appropriate way to handle multiple debt issues.
c) If BP does not have publicly traded debt (and/or both the previous two approaches did not work), you will need to read the footnotes to the annual report. You may be able to get their estimated borrowing rate. After gathering the information:

1. Estimate BP's weighted average cost of capital. You can use the income statement information to estimate the tax rate.

2. If your company uses this in the capital budgeting process (i.e., as the discount rate in NPV and IRR), what assumptions are they making?

3. Does your company face any particular difficulties in using this rate? For example, does your company have different divisions or units that might have differing levels of risk?

Please write up a 1-page summary of your findings, including any calculations you might have made, and describe which method you used to find the required rate of return on debt for your company.