Apache Corporation Equity Valuation and Analysis. Analyst Group

Apache Corporation Equity Valuation and Analysis Analyst Group Dillon Blaine Rebecca Wood Ben Gergen Christopher Cotter Dustin Shimek dillon.blaine@ttu.edu Rebecca.wood@ttu.edu b.gergen@ttu.edu scott.cotter@ttu.edu drshimek@hotmail.com 1

Table of Contents Executive Summary 5 Business & Industry Analysis 10 Five Forces Model 14 Rivalry among Existing Firms 15 Threat of Substitute Products 19 Threat of New Entrants 22 Bargaining Power of Buyers 26 Bargaining Power of Suppliers 27 Value Chain Analysis 29 Firm Competitive Advantage Analysis 32 Accounting Analysis 33 Key Accounting Policies 34 Potential Accounting Flexibility 39 Actual Accounting Strategy 41 Quality of Disclosure 42 Qualitative Analysis of Disclosure 42 Quantitative Analysis of Disclosure 44 Sales Manipulation Diagnostic 45 Expense Manipulation Diagnostic 50 2

Potential Red Flags 55 Coming Undone (Undo Accounting Distortions) 56 Financial Analyst, Forecast Financials, and Cost of Estimation 56 Financial Analysis 56 Liquidity Analysis 57 Profitability Analysis 66 Capital Structure Analysis 73 IGR/SGR Analysis 77 Financial Statement Forecasting 79 Analysis of Valuation 90 Method of Comparables 90 Cost of Equity 98 Cost of Debt 101 Weighted Average Cost of Capital 101 Intrinsic Valuation 102 Discount Dividend Model 102 Free Cash Flows Model 103 Residual Income Model 104 Abnormal Earnings Growth 106 Long Run Return on Equity Residual Model 108 Credit Analysis 110 Analyst Recommendation 111 3

Appendix 113 Liquidity Ratios 113 Profitability Ratios 114 Capital Structure Ratios 115 Method of Comparables 116 Regression Analysis 118 Discount Dividends Model 124 Free Cash Flow Model 125 Residual Income Model 126 Intrinsic Valuation Model 127 Abnormal Earnings Growth Model 128 Altman Z-Score 129 References 130 Executive Summary Investment Recommendation: Overvalued, Sell (11/1/06) 4

APA- NYSE(11/1/06): $99.18 52 Week Range: $63.01-$107.73 Revenue: $8868.994M Market Capitalization: $32.72B Shares Outstanding: 330.737M Percent Institutional Ownership: 82% Book Value per Share: $39.88 ROE: 18.60% ROA: 9.95% Cost of Capital Est. R2 Beta Ke Estimated: 3-month.19 1.6 4.01 6-month.19 1.6 4.22 2-year.19 1.6 4.03 5-year.19 1.59 4.22 7-year.19.14 4.33 10-year.19.14 4.52 Published Beta:.76 Kd(AT): 4.74% WACC(BT): 8.52% WACC(AT): 5.54% *Irrelevant due to negative cash flows Altman s Z-Score: 2002 2003 2004 2005 2006 3.51 3.97 2.72 3.13 3.32 Valuation Estimates: Actual Price (11/1/06): $99.18 Financial Based Valuations: Trailing P/E: $82.02 Forward P/E: $93.41 P.E.G.: $59.88 P/B: $103.29 P/EBITDA: $75.65 P/FCF: N/A* EV/EBITDA: $97.24 Intrinsic Valuations: Discount Dividend: $6.62 Free Cash Flows: $126.84 Residual Income: $37.72 LR ROE: *N/A AEG: $19.23 http://moneycentral.msn.com http://moneycentral.msn.com Industry Analysis Apache was formed in 1954 in Minneapolis, Minnesota by Truman Anderson, Raymond Plank, and Charles Arnao. They have grown to be one of the leading independent oil and gas exploration companies in the United States. The company 5

currently has 24.3 billion in assets and sold 10.6 billion dollars worth of oil and gas in 2006. Apache currently has operations on 37.6 million acres in 6 different countries around the globe. Apache s main competitors consist of Occidental Petroleum, Anadarko, XTO Energy, and Devon Energy. They compete in a very competitive industry where commodities are sold. This means the products they sell are virtually identical, making price a deciding factor with their customers. In an industry with high entry barriers, it is impossible to build a corporation with 24.3 billion in assets overnight. Brand name and reputation are imperative in this industry since all products are identical. The key success factors upon which firms compete are economies of scale, successful exploration, tight cost controls, and retention of employees. These key success factors are the building blocks to gaining market share, and maintaining profitability and competitive advantages over their competitors. In an industry with low product differentiation and almost zero substitute products, these key success factors are all the more important to each company. Accounting Analysis Being successful in the oil and gas industry strongly relies on the key success factors relating to key accounting policies. Accounting policies are important to recognize due to the fact that managers are allowed flexibility under GAAP and can use 6

option to make financial statements appear more appealing than they really are. Managers are motivated to do this because keeping shareholders around is important to their jobs. Apache, when thoroughly looking over their financial statements, showed a high level of disclosure of their business practices and accounting policies. Any bit of information was found in the company s 10-K and annual report of various years with small amounts of searching. Apache included much information about their operating leases, the full amounts owed and the discount rates used to value payments on the leases at future dates. Discount rates for pension liabilities and other long term liabilities were also revealed. Discount rates for these items are an area that flexibility is used a lot. However, when reviewing and performing the accounting analysis, no outlying ratios and numbers caught our eyes. Everything was pretty much with the industry norms. Overall, Apache did a good job of making transparent financial statements that disclose information desired by analysts and investors. Financial Analysis, Forecast Financials, and Cost of Capital Estimation There are many financial ratios that analysts use to dissect a company s financial statements so they are able to compare them to their competitors. These ratios look at the firm s liquidity, profitability, and capital structure. These ratios are used to forecast 7

out a firm s financial statements so analysts can determine the value of a company, and see the changes in the firm through time. Analysts also run a regression of the company to determine a beta, cost of equity, cost of debt and a weighted average cost of capital. The liquidity ratios computed were the current ratio, quick asset ratio, inventory turnover, receivables turnover, and working capital turnover ratios. The ratios determine the firm s ability to have enough near-cash assets to meet their debts and obligations as fast as possible. These ratios show that Apache is in line with the industry. The profitability ratios determine a company s operating efficiency, asset productivity, rate of return on assets, and rate of return on equity. Apache s profitability ratios show that Apache is, again, in line with the industry. The only exception is the inventory turnover ratio, because not many of Oil Corporations in the industry have inventory, so Apache is unusually high. Finally, the capital structure ratios refer to the sources of financing used to acquire assets. This is shown by the owner s equity and liabilities sections of the balance sheet. All of Apache s ratios are in the same range as their competitors. We then forecasted out Apache s balance sheet, income statement, and statement of cash flows for the next ten years. We forecasted using industry averages, Apache s past growth rates, and ratios. We took into consideration recent asset acquisitions and natural disasters when forecasting so the future numbers were realistic and reliable. Valuations Analysts have several tools when trying to value a company s stock price per share. Before using these tools, analysts must have a good understanding of the company as well as its business environment. After completing an overall industry 8

analysis, accounting strategies, and determining key success factors of the company, the analyst is familiar enough with the company to value it. The Method of Comparables and the Intrinsic Valuation model are important in determining if a firm is overvalued, overvalued, or fairly valued. The method of comparables is a measure of a company s stock price per share. This model is unique because it is based on the competitors in the industry. The industry average does not include the company you are valuing. This can potentially create problems when trying to accurately value a stock. Under this model, many assumptions such as all companies in the industry are the same size and they operate in the same way. After the industry average is found, it is used in several calculations to determine the stock price per share. From here, it is clear if a firm is overvalued, undervalued, or fairly valued. Clearly, this model is not the most reliable or accurate because of the assumptions it makes. According to this valuation model, Apache s stock price was overvalued based on all but two of the models. The Forwarding Price to Earnings and Enterprise Value to EBITDA ratios reported Apache as having a stock price as fairly valued. This should not be the only valuation measurement for a company, due to the inconsistency of the model. The Intrinsic Valuation model is a more complete and detailed form of valuing a company s stock price per share. In total there are five intrinsic valuation models that focus on different areas of the company. The Discount Dividend model is not the most reliable out of these valuations. Dividends must be forecasted out using a constant growth rates. It is not likely that a company s dividends will grow at a constant rate for an indefinite period. According to this model, Apache s stock price per share is overvalued. The Free Cash Flow model is another valuation that is not always accurate. This model basis its valuations off of forecasted cash flows from operations and cash flows from investing. The result of this valuation was that Apache s stock price per share was overvalued. Next, the Residual Income valuation is the most reliable because the overall value of the firm includes a high percentage of the present value of residual income. Based on this model, again, Apache s stock price per share is highly 9

overvalued. Apache s stock price valued using the Abnormal Growth Model and the Long Run Residual Income model was overvalued. Therefore, the valuation models support that Apache s stock is overvalued. Business & Industry Analysis Overview of Firm Apache Corporation is an independent oil and gas company that was created in 1954. The company s interest is in exploration and production of crude oil, natural gas, and natural gas liquids. Apache is one of the largest independent oil and gas companies in the nation and has operations in six countries including the United States, Canada, Egypt, Australia, Argentina, and the United Kingdom. Apache has a variety of operations ongoing on and offshore in these countries. The company went public in 1969 and its shares were first listed on the New York Stock Exchange under the symbol APA. Apache Corporation is headquartered in Houston, Texas. Apache operates in an industry where acquisitions of property from other exploration companies are the norm in the way of purchasing prospects for drilling and exploration. Seldom is land acquired that is undeveloped or not yet been looked over by other firms. Apache acquires prospective properties through buying other larger firms drilling interests and by bidding for offshore blocks of water from governments. These bids and purchases of other firm s drilling rights initiate much competitiveness throughout the industry. Consequently, firms with more capital to work with generally have a better chance of acquiring lands and deepwater blocks. Apache competes with vast numbers of companies that have more capital and resources to work with. In recent times, many major integrated oil companies have focused more on exploration worldwide instead of just on their home turf. This has left many opportunities for acquisitions for smaller independent oil and gas companies. There are about 5000 independent oil and natural gas producers in the U.S. Independents drill 90 percent of 10

the wells in the U.S. and produce 68 percent of America s oil and 82 percent of domestic natural gas (www.ipaa.org). Apache distributes its crude oil to larger integrated oil companies, refineries, and other purchasers. Natural gas products are sold to Local Distribution Companies, integrated oil companies, utilities, and certain end users. Apache focuses on distributing to markets that are most economically feasible for them to supply because they will bring the most revenue. Oil and natural gas are commodities and that causes buyers of this industry s product to always search for the cheapest product. Therefore, one of Apache s main objectives is to maintain efficient and low cost production. Apache, like the industry, depends heavily on the current price of oil and gas for profits. Being commodities, oil and gas are subject to severe price volatility. This has lead firms in the industry to engage in hedging activities to protect themselves against price fluctuations, and also exchange rate risks when converting foreign money back to U.S. dollars. Being smart about hedging is very important to Apache because it can make the difference between losing money and/or missing out on additional profits. From the tables below, it is noticeable that Apache s revenues and assets rose substantially in the past few years while the company kept its production of oil and gas at relatively the same level. This represents how dependent Apache and the industry s profits are upon fluctuating prices worldwide. Apache Corporation Annual Revenues 2002 2003 2004 2005 2006 $2,560 Million $4,190 Million $5,333 Million $7,584 Million $8,289 Million Apache Corporation Total Assets 2002 2003 2004 2005 2006 11

$9,460 M $12,416 M $15,502 M $19,272 M $24,308 M Apache Oil and Gas Produced Daily Worldwide (avg.) 2004 2005 2006 Oil 231,519 barrels 234,070 barrels 224,577 barrels Natural Gas 1,235,108 Mcf 1,263,823 Mcf 1,589,065 Mcf In the past 5 years, Apache, along with the industry, has grown significantly due to elevated global oil prices. High prices mean larger profit margins, and this has given many companies the capital and additional boost to explore in more places and indulge in more high-risk/high-return ventures. Since 2002, the company has made many acquisitions in several different countries, adding to their assets and assisting revenues. In 2003, Apache acquired the Forties Field from British Petroleum for $630 million. The Forties Field is one of Apache s largest assets and continues to be a top producer of oil in the world. Also in 2003, a natural gas well discovered in Egypt proved to be the largest discovery in the company s history. In 2003 and 2004, several large acquisitions in the Gulf of Mexico from BP, Anadarko, and Shell Oil provided oil producing properties, facilities, and prospects. In 2004 and 2005, Apache signed two separate farm-in agreements with Exxon-Mobil totaling over 1 million acres of promising, undeveloped land in Alberta, Canada. Apache has acquired many lands in Egypt on and offshore in the past few years producing $1.66 billion in revenue, accounting for nearly half of the company s international revenue. (2006 Apache 10-K) The company also tries to strategize by not only acquiring new prospects, but by selling off current properties and land interests that produce that the company feels the 12

proceeds from would benefit the company more elsewhere. These sell offs, known as divestitures, occur often and become acquisitions of other firms in the industry. http://moneycentral.msn.com Since September of 2002, Apache s stock has risen significantly to a price of $83.19 in September 2007 from an adjusted split price of around $28 per share accounting for 2 stock splits in those five years. The industry on average is doing just as well and some of Apache s immediate competitors stock performances have done reasonably better. This could partially be due to Apache having a smaller market capitalization than some industry competitors such as Devon Energy and Occidental Petroleum, and therefore less capital and funds to work with in competing for drilling and exploration rights. Other competitors have a slightly smaller market capitalization, an example being XTO Energy, and the stock is outperforming Apache s. Anadarko Petroleum Company is a competitor whose market capitalization is slightly smaller than Apache s and their stock 13

has been running right below Apache s. Occidental has a market cap of $50.77 billion, Devon with $35.48 billion, Anadarko with $23.7 billion, and XTO Energy with $23.37 billion. Each company s reserves also play a big role in adding value to the company and influencing the stock price. Reserves are an asset that has a value that is always subject to change. A change in the price of oil will cause an asset change and affect future cash flows to the company. Competition in oil and gas is very strong. Understanding the nature of this industry and the way in which Apache operates is crucial to being able to evaluate and value Apache in this analysis. Five Forces Model Porter s Five Forces model is a business tool used to assess the competitiveness and value drivers in any given industry. The model gives outside analysts the ability to analyze the industries that certain companies operate in and therefore can better understand significant market share builders. The five forces used to analyze any industry are rivalry among existing firms, the threat of new entrants, the threat of substitute products, the bargaining power of suppliers, and the bargaining power of customers. Each aspect of the model differs from one industry to the next and will affect the industries in varying degrees. Understanding the degree of competition in a given industry is imperative when analyzing how effective a company is at operating in the industry. Oil and Gas Industry 14

Rivalry Among Existing Firms Threat of New Entrants Threat of Substitute Products Bargaining Power of Buyers Bargaining Power of Suppliers High Low Moderate Low Low Rivalry among Existing Firms The independent oil and natural gas production and exploration industry operates in a highly competitive environment. Many factors affect the degree that companies are forced to compete within the industry. These factors include the industry growth rate, concentration and balance of competitors, switching costs, differentiation, excess capacity, and exit barriers. Each company must confront these factors in order to stay competitive and profitable in the market. The companies that are able to deal with these factors effectively will have the best chance of success. Industry Growth Rate Oil and natural gas production growth began to slow over the past two years. In 2006 the world produced only 0.04% more oil than it had in 2005. This decline can be attributed to the discovery of most of the conventional sources of oil. The relative stagnant growth in the industry will force companies in the industry to compete more aggressively for the remaining known oil reserves. As the discovery of easy oil begins to decline companies in the industry will be forced to compete to find sources of oil which are considered unconventional, such as heavy crude oil, tar sands, and oil shale. 15

The cost associated with producing oil from such sources is substantially higher than production of conventional sources. Also, as production growth begins to slow the market price of oil and natural gas rises. This increase in price increases the cost of acquiring new properties for the production of these resources. World Oil Production 16

Concentration and Balance of Competitors The level of concentration in the industry has risen over the past few years as major integrated companies such as Exxon and Mobil have merged. The increase in concentration gives larger companies the ability to set and enforce the rules of competition. It also gives the leaders more of an opportunity to influence worldwide prices which are set by the market. The leaders in the industry have access to much larger financial and other resources which puts them at a comparable advantage to the rest of the industry. The advantaged leaders have made it more difficult for the rest of the industry to acquire drilling rights and land especially in countries where they have established strong relationships with the government. These events have made it much more difficult for the independent companies in the industry to compete directly with the major integrated companies. Yet, independents drill 90 percent of our nation s wells, produce 68 percent of the United States oil and 82 percent of America's natural gas. (Independent Petroleum Association of America, ipaa.com) Differentiation 17

Differentiation in the oil and natural gas production and exploration industry does not exist. All companies in the market are producing the same commodities, crude oil and natural gas. The difference comes from how efficient a company is at producing these resources. The costs incurred by buyers when switching suppliers is low in the oil and gas industry. This is directly affected by the fact that oil and natural gas prices are set by the world markets. Excess Capacity and Exit Barriers The world demand for oil and natural gas is very high and is expected to increase in the future. World oil consumption increased by more than 817,000 barrels from 2005 to 2006. From the graph below we can see that the Energy Information Administration forecasts show that the demand for oil will continue to grow at a steady pace for the near future. Since there is such a high demand on oil exiting such a profitable industry should not be very difficult. If a company wanted to leave the industry they should be able to sell their assets to competing firms or private investors. Competing firms in the industry are always looking to buy oil reserves and rights from known sources currently held by other companies. 18

Threat of Substitute Products The threat of substitute products in the oil industry has only become a problem in recent years. Since gas prices are a necessity and also very expensive, a substitute seems ideal. Potential substitutes include ethanol fuel, solar powered vehicles, electric powered vehicles, and hybrid vehicles. The most direct substitute for gasoline is ethanol fuel. Though technology has not yet perfected its uses, in the future, the oil industry will have a potentially large threat of substitution. The other substitutes are only available to replace gasoline in cars. Technology has not developed energy storage as a use of power for larger machinery, such as planes or semi-trucks. This has an effect on the oil industry, but not enough to cause permanent harm. Buyers Willingness to Switch With the constant rise of gasoline prices, drivers often hope for a cheaper substitution. The current substitutions for gasoline are not perfected and not practical. Ethanol appears to be a great substitute for the high gas prices customers deal with everyday. The reason ethanol is not a huge threat to oil companies is because of its major drawbacks. In order for a car to run on pure ethanol fuel (E100), a new engine is required. Also, in order for an engine using ethanol to produce the same amount of energy as an engine using gasoline, the engine would require a substantially larger amount of ethanol than gasoline. Another drawback to using ethanol instead of gasoline is, depending on where you are located, it is hard to find. Because E85 is primarily sold in the upper Midwest, most drivers in the country have no access to the fuel, even if they want it (www.consumerreports.org). This does not allow drivers in certain areas to even have the option of switching. A substitution for gasoline that is only available for cars is solar power. A solar car is an electric vehicle powered by solar energy obtained from solar panels on the surface of the car (www.wikipedia.com). Technology has not developed far enough for the use of solar cars to be practical for daily use. In order for a solar car to meet the safety standards and comfort level of standard gasoline powered cars, it would 19

require the vehicles to be much heavier and larger than standard solar powered cars to reach the same speeds. Technology has not yet perfected the use of solar power to run cars efficiently and effectively. This is why solar powered cars might become a potentially large threat of substitution of gasoline, but currently is only a small portion of the oil business that will be taken away. Another substitution for gasoline only available for cars is electricity. The electric car, EV, or simply electric vehicle is a battery electric vehicle (BEV) that utilizes chemical energy stored in rechargeable battery packs. Electric vehicles use electric motors and motor controllers instead of internal combustion engines (www.wikipedia.com). The electric car has many benefits, such as it is more energy efficient, gives off less pollution, and is quieter than conventional gasoline powered vehicles. Although electric powered cars may seem more beneficial, there are drawbacks as well. Some problems include, high battery costs, limited travel distance between battery recharging, charging time, and battery lifespan, which have limited widespread adoption (www.wikipedia.com). Also, ownership costs for battery electric cars are higher than for their petrol or diesel equivalents, primarily because their purchase price is higher to begin with. Typically for a new car, or a small van, the price is increased by up to 80% (www.wikipedia.com). While electric cars have benefits and could potentially replace gasoline powered cars, the likelihood of the entire driving population to purchase an entirely new vehicle is not foreseeable, and as of now does, not post a large threat to the oil industry. The hybrid vehicle is partially a substitution for gasoline, because it is still required to use a smaller amount to power a car. A hybrid vehicle (HV) is a vehicle that uses two or more distinct power sources to propel the vehicle (www.wikipedia.com). These power sources include gasoline and stored energy, such as solar power, or battery power. The threat of substitution with hybrid vehicles is existent, but not threatening to the oil industry. Although hybrid vehicles significantly cut down on the use of gasoline, gasoline is still used. Hybrid vehicles would only become a large threat if the entire driving population purchased hybrid vehicles, which due to their high cost is not 20

likely to happen. Relative Price and Performance The performance of gasoline and ethanol fuel is relatively the same, although the prices of gasoline and ethanol fuel are not. Ethanol fuel is much more expensive than current gasoline prices. With the retail pump price of E85 averaging $2.91 per gallon in August, according to the Oil Price Information Service, which tracks petroleum and other fuel prices, a 27 percent fuel-economy penalty means drivers would have paid an average of $3.99 for the energy equivalent of a gallon of gasoline (www.consumerreports.org). Also, ethanol fuel requires a different kind of engine than standard cars already have, which is another required expense. The performance of gasoline and solar power are only interchangeable when it comes to cars. Solar powered cars can be a direct substitution of gasoline powered cars, but require extra money and effort. The drawbacks to solar powered vehicles have not been corrected and also cost a lot more money than filling up a tank on a standard gasoline powered car. The relative performance of solar cars can be compared to gasoline powered cars, but cannot directly be switched without extra investments. Prices of solar power and gasoline are also substantially different, because a new vehicle is required in order to run solely on solar power. Similarly to solar power, using electricity as a substitute for gasoline can only be used for small vehicles. There is really no price similarity between gasoline and electricity because to be able to switch to electricity, a new car is required. The performance of electricity compared to gasoline has many drawbacks as well. Finally, a hybrid vehicle reduces the amount of gasoline required, but does not completely replace it. The performance of a hybrid car can be compared to the performance of a gasoline powered car, but cannot be compared in price. Hybrid cars 21

are much more expensive than standard gasoline powered cars, so they cannot directly substitute it; just minimize the amount of gasoline required. Conclusion Although there are potentially many threats of substitution of gasoline, the likelihood of being able to completely stop using gasoline is slim to none. The substitutes are too expensive and not easily accessible to the entire driving population. Also, technology has not yet perfected the uses of substitute products for day to day use. Currently, the oil industry is not posed with a major threat of substitution. Some day, when technology has developed these gasoline alternatives more, the threat will become very great and the oil industry will greatly suffer. Fortunately that day is far into the future and the only readily available, accessible, and affordable fuel is gasoline. Threat of New Entrants The oil and gas industry is comprised of a handful of large corporations as well as several smaller, more competitive firms. The large oil and gas corporations have found ways to stay on the cutting edge of new technology which enables them to produce oil and gas more efficiently. Newer and smaller firms entering the market will have several obstacles to overcome because they have considerably less market share and initial capital. For example, Apache oil Corporation has been operation for 54 years and has the experience and knowledge necessary to remain a dominate player in the oil and gas industry. A few of the hurdles that new competitors might face include economies of scale, establishing relationships with customers, and legal barriers to name a few. New firm survival is not likely in this industry due to several dominate companies already in existence. 22

Economies of Scale New firms that generate enough start up capital to enter the industry still face many challenges. The survival of these firms is still minimal because of major corporations ability to purchase large quantities of resources and land at one particular time. This leaves the smaller firms to fend for themselves which in many cases leads to their extinction. Another reason many new firms cannot survive the industry is because existing corporations have established often exclusive relationships with long time clients and distributors. Another key factor in the oil and gas industry is a firm s location, because it has a direct impact on the quality and quantity of resources acquired. The oil and gas industry is highly competitive. As an independent oil and gas company, the Company frequently competes for reserve acquisitions, exploration leases, licenses, concessions and marketing agreements against companies having substantially larger financial and other resources than the Company possesses. To the extent the Company's capital budget is lower than that of certain of its competitors, the Company may be disadvantaged in effectively competing for certain reserves, leases, license, and concession (www.secinfo.com/dsvru.9266.htm). Also, competitive pricing among established firms is almost impossible for new firms to compete. The factors listed above give existing firms a clear cut advantage in the industry. It has been proven in the oil and gas industry that larger, more dominate firms have an advantage. The chart below shows some of the leading oil and gas exploration companies and their total assets per year. A market dominated by a few large corporations, such as the oil refining market, can be particularly difficult for small companies to enter. It can be difficult because larger companies benefit from economies of scale and can conduct such a competitive pricing policy that it is impossible for a new entrant to make a profit (www.encyclopedia.farlex.com). In the chart below, it demonstrates how volatile oil companies assets are as a result of fluctuating oil prices. In recent years, many of these companies total assets have more than tripled, not being necessarily due to an increase in quantity of assets, but value of assets. Total assets in this industry are often difficult to correctly value because most 23

of a company s long term assets are reserves. The reserves are estimated by outside private companies as to the total amount of oil in each reservoir that is able to be extracted in the future. Because there are millions of acres of reserves and the price is constantly changing, often total assets are grossly over or understated. Total Assets 2002 2003 2004 2005 2006 Apache Oil Corporation 9,459 12,416 15,502 19,272 24,308 Anadarko Petroleum 18,248 20,546 20,192 22,588 58,844 Corporation Devon Energy 16,225 27,162 30,025 30,273 35,063 Occidental Petroleum 16,548 18,168 21,391 26,108 32,355 Corporation XTO Energy 1,118 1,252 2,043 9,857 12,885 *in millions Distribution Access and Supplier Relationships One of the biggest problems facing relatively new firms entering the oil and gas industry is loyalty among customers. Large firms in this industry have established relationships with customers. Keeping customers satisfied is a major consideration of large companies. Customer base is difficult to establish and often contracts are drawn to insure customer loyalty. Both the oil company and the customer use this to their advantage when it comes to distribution and supplier terms and conditions. Since, Apache Oil Corporation is the supplier to many firms there is no direct supplier relationship between Apache Oil Corporation and any other firm. However, Apache Oil Corporation and other firms must establish and maintain relationships with distributors. 24

Apache Corporation sells its natural gas to local distribution companies, utilities, endusers, integrated major oil and gas companies, and marketers; and crude oil to integrated oil companies, purchasers, transporters, and refiners (www.investing.businessweek.com). So, a good relationship with distributors is a invaluable tool when it comes to the success of a firm. Legal Barriers The oil exploration industry has many barriers for entry. New or existing corporations must gain approval from many agencies, including regulation from state and federal governments. In order to begin the often lengthy exploration process drilling must be regulated by state and federal environmental laws. When looking for new exploration sites, firms can often receive criticism from groups like the Energy and Natural Resources Committee, which is extremely influential. Obstacles such as this can completely halt all operations of a firm. Firms can also face opposition from conversationalists who fight against the negative effects oil and oil spills can have on the environment. Drilling in Alaska has been a hot topic for some time now. Established exploration companies have faced harsh criticism among opponents of oil exploration in the western Artic Ocean. Climate change, caused by burning oil, coal and gas, is causing the western Arctic to warm three times faster than any other part of the globe. The survival of many species; such as polar bears, walrus, and reindeer, is currently threatened by retreating ice and unseasonably warm weather (www.cnn.com). Firms who wish to get out of the oil and gas industry face little barriers to exit. They simply sell their equipment and supplies to another firm wishing to acquire more assets. However, oil and gas exploration is a global effort, so firms must keep in mind international laws and regulations. Conclusion The oil and gas exploration industry is highly competitive. This makes it extremely difficult for new firms to enter the industry and be successful. In order to enjoy economies of scale, firms must properly manage their resources and other assets. Relationships with distributors are also a key factor in keeping or establishing a 25

successful firm. There are many legal barriers to entry such as state and federal environmental laws, and resistance from conversationalists groups. These factors make new entry extremely hard, and most of the time the attempts to enter are not successful. Bargaining Power of Buyers In the oil industry, consumers do not have much say. The only bargaining power that consumers have is if the product is not necessary to their daily lives, or if consumers have the power to force the price down. Nearly everyone in the United Stated needs oil and the prices are predetermined, so US consumers are forced to live with the standards the oil industry set. Price Sensitivity Price sensitivity results from the customers willingness to negotiate on price. The majority of people in the United States are drivers. Overall, there were an estimated 243,023,485 registered passenger vehicles in the United States according to a 2004 DOT study (www.wikipedia.com). Because most of the US population does drive a car, gasoline is a commodity. In a commodity market, the only possibility of straying away from that commodity is to switch. The likelihood for drivers to spend extra funds to change to a gasoline alternative is very small, because the extra funds necessary are very large. Relative Bargaining Power Relative bargaining power is the success that a consumer can achieve when trying to force the price down. In the oil industry, consumers do not have the advantage of relative bargaining power because the price of oil is preset. Gas prices are determined largely by the Organization of Petroleum Exporting Countries, or OPEC. The amount of crude oil produced by OPEC determines the price of a barrel of oil (www.cnn.com). Relative bargaining power depends on the cost of not doing business with the other party. Since oil is a commodity and the majority of US citizen cannot live 26

without it, there is no option of not doing business with the oil industry. In 2004, the total crude oil and petroleum products sold in the United States were 7,587,601,000 barrels. The likelihood for all consumers of oil products to put in extra funds and switch is not expected. Conclusion Although US consumers would be much happier given the power to refuse to buy gasoline or to force the prices down, the probability of that happening is slim to none. The oil industry has a strong grip on consumers because oil is a commodity. Until the day oil is no longer market determined in the US economy, the market will continue to sell and set the price of oil. Bargaining Power of Suppliers The amount of bargaining power suppliers have can have a huge impact on the market as a whole. Bargaining power is where the firm has the ability to set prices. The oil and gas industry is unique in the since that there is no close substitute for their product. In an industry with low bargaining power, the firm has little to no say when it comes to setting prices for the market. The firm also has no bargaining power when it comes to the terms and conditions set by suppliers. In contrast, a firm in an industry with high bargaining power has more control over price setting in that particular market. Firms are also in control of terms and conditions because the supplier wants to create and maintain a long relationship with the firm. For example, firms in the oil and gas industry have low bargaining power since each firm is extracting the same product. However, in an industry with a lot of competition, such as the oil and gas industry, no one firm can set the market price. In the oil and gas exploration industry, the oil and gas companies are the actual suppliers. Since oil does not have a direct substitute, the companies in this 27

industry have a lot of power, even though their bargaining power is low. The companies in the industry may have a lot of power, but since there is so much competition the firms must keep their prices, term and conditions, etc. similar to their competitors. Price Sensitivity One of the most important aspects to consider when choosing a supplier is price. Firms mainly compete on low cost and quality, making suppliers who can meet those demands stand out among the rest. The degree of switching power among firms varies based on their sensitivity to price. In an industry with low switching costs, firms have little or no bargaining power. This is because firms are able to switch suppliers frequently to find the lowest price and best quality. In this type of industry, there is no customer loyalty which makes developing relationships with suppliers difficult. However, in an industry with high switching costs, firms stay with suppliers due to the high cost of switching. In this industry, customer loyalty and relationships with suppliers are formed. Given that the oil and gas industry is so competitive, and each firm is creating basically the same product, switching costs are rather low. A firm is able to find the same product from any of the other firms within the oil and gas industry. Relative Bargaining Power Relative bargaining power is what sets one product apart from another. If a product is extremely unique and there are no close substitutes, then that firm has a high level of relative bargaining power. If a product has many close substitutes, then that firm has little to no relative bargaining power. The companies in the oil and gas industry extract the same product and there is little differentiation among firms. This means, suppliers in this industry have a low amount of relative bargaining power. Competitors in the industry such as Anadarko Petroleum Corporation, Devon Energy, Occidental Petroleum Corporation, and XTO Energy all extract and supply the same product. For example, when a customer wants 28

oil or gas and contacts Anadarko Petroleum Corporation, if they are not satisfied with the price or service, they can easily switch to Apache Oil Corporation and receive the same product. The oil and gas industry is not an industry that competes based on differentiation. The industry competes with other firms on the basis of price and availability of resources. Firms in the industry are always looking to expand and acquire new land for exploration. This is where the competition is found in this particular industry, not on differentiation of products. Conclusion Bargaining power of suppliers in the industry can have a huge effect not only on customers, but on the market as a whole. Firms in the oil and gas industry have low bargaining power because all the firms are extracting the same resource. Price sensitivity is a major factor when a customer selects an initial supplier. Firms in the oil and gas industry compete mainly on low price. Switching costs are relatively low, considering competitors produce products that are the same. Firms in this industry try and differentiate themselves by acquiring more land and reserves. For example, a firm that is drilling in several parts of the world is going to be more powerful than a firm that is concentrated in only one region. Most of the suppliers in this industry can supply the same product. This is why the overall bargaining power of suppliers is considerably low, even though there is no close substitute for oil. Creating value in the Oil and Natural Gas Industry In order to gain value and market share in the oil and natural gas industry there are a few important qualities or in some cases imperfections in an organization s corporate strategy which can have a big effect on the company s value and long term success. Like most corporations in the industry, Apache s mission is to profit from our growing business that unites our (Apache s) employees, partners, suppliers and 29

shareholders in the fulfillment of our long term mission (www.api.org). In common terms the goal is to increase profit and shareholder wealth. Creating value in this industry relies on exploration, transportation costs, mergers/acquisitions, and complying with the ever changing global environmental regulations to combat global warming. This industry is one with low bargaining power as there is no current substitute for oil and gas and as a result no one firm in the industry can set and establish the market price. What this creates is a rush by all the competing firms to most effectively manage the costs of exploration, licensing, and complying with environmental regulations in order to get the product to the customers at a cheaper price. In this industry the costs of switching from one supplier to the next are non-existent. What Apache has, Devon Energy (a main competitor), can supply at a cheaper price of pennies to the dollar and as a result force Apache to either lower prices or lose customers and the millions of dollars that come with it. While the U.S. is the 2 nd largest oil producer in the world, it is no longer able to supply its own needs for crude oil. What this means to the industry is that the key to gaining value and market share is to find the large oil reservoirs. After a firm spends money on exploring and finding the reservoirs they need to determine who owns the mineral rights to the reserves. If privately owned, these reserves are acquired by a lump sum of money and in most cases a percentage of the royalties from the gas or oil pumped from the reserve. In the US, if mineral rights are owned by the federal government, they are put on the auction block and sold to the highest bidder. A key component of this system is that these auctions involved sealed envelopes with each companies bid. After opening all of the bids, the government gives the reserves to the highest bidder. This can make it very hard for an emerging corporation to gain market share as companies with already established markets can outbid and increase their reserves. Unlike companies that are integrated refiners, a corporation that owns both a refinery and a branded presence in the gasoline retail market (Exxon, Shell, BP), 30

Apache and its competitors have the most risk due to the vast majority of their revenue coming from acquiring, drilling, and refining. These non-integrated refiners ultimate desire is to get its product to market, from the refinery, through a pipeline, or other method of transportation, to a terminal, via truck to a station, and then sold to a customer (www.api.org). As a result the incentives are clear for the companies, the more efficient the distribution, the lower the end cost of gasoline distribution. Apart from lowering the end costs of distribution, marketing and managing a companies brand name is also very important in gaining value in the industry. In economic terms, the value of a brand is represented by the amount consumers are willing to pay producers for an implicit promise of value. The promise of value deals with goods whose quality is not obvious upon inspection. The branding of a product also implies product consistency that the product will have the same quality each and every time it is purchased by a consumer (www.api.org). Establishing a respected brand name in the industry creates almost as much value as the competition for reserves. To establish a brand you have to sell quality services and substances for an extended period of time which builds a positive reputation in the consumers mind. This makes it difficult for other firms to try and enter this market. Furthermore it makes it more expensive to advertise against competitors and establish the most trusted brand name in the industry. Conclusion As this is a highly competitive industry with very little bargaining power, gaining value and maintaining and expanding market share are even more important. The corporate strategies which create value and competitive advantages are in advertising and maintaining brand reputation. Also it is very important to find reservoirs before the competitors and be able to afford the high level of risk involved in drilling and exploration. Lastly the most important factor in value creation which creates the greatest competitive advantage is to go from reserve to the end consumer most efficiently and as a result be able to provide the cheapest product on the market. 31

Firm Competitive Advantage Analysis Since 1954, the goal of Apache Oil Corporation has been to acquire resources and get the most out of remaining reserves. For example, in 2006, Apache Oil took over Exxon s shares of the North Sea, which is 20% of the known Mineral licenses of the United Kingdom. In the past, it has been difficult for Apache to acquire lands because the industry was primarily dominated by major integrated oil companies. They made a successful move in 1980, by engaging in a joint venture with Shell Oil Company in the Gulf of Mexico. This got their foot in the door and helped establish their credibility among the industry. In the years following, the major companies began to leave the United States in search of international success. Independent oil companies began acquiring major oil companies U.S. assets. Presently, Apache Oil Corporation is the largest held by production lease holder, and fourth largest producer on the off shore continental Shelf in the Gulf of Mexico. Apache has also made several key acquisitions world wide in countries such as Egypt, Canada, The North Sea, United States, and Argentina. Apache is known for their ability to acquire lands, and this is a definite competitive advantage over competing firms. As long as they continue this trend, they should be successful in the future. Proven acquisitions are coupled with Apache s ability to successfully find promising prospects. For example, in 2006, 87% of new wells drilled were producers. Apache does a good job of exploration by hiring exceptionally skilled geologists and petroleum engineers. They maintain employee retention by paying competitive salaries. Employee retention is important because of the diminishing number of qualified employees in the industry. For the past 21 years, Apache s reserves have been steadily increasing, creating a need for more qualified employees. Since Apache went public in 1969, stock prices have increased and split multiple times. This is a reflection of the company s reputation as well as its success. In an industry where you can not tell one product from another, brand name is vital to a 32

companies continued success. Apache established their name years ago, and has continued to maintain it through normal operations. Their reputable name will continue to ensure their future sales to customers. Accounting Analysis Shareholders and investors rely on a company s financial statements to give them a more in-depth look into the company. Financial statements are important in determining the value of a company. They are beneficial in identifying problems within the company and identifying areas of improvement. The information contained in the income statement, balance sheet, and statement of cash flows helps investors determine whether or not to invest in the company. Generally Accepted Accounting Policies (GAAP) are the standards of accounting in the United States. These standards make comparing financial statements more efficient due to the consistency GAAP creates. However, GAAP allows choice, or more than one way in reporting of the same transaction. GAAP allows for firms to disclose their true economic circumstances rather than a strict universal code of reporting. Because of GAAP s flexibility, accounting analysts need to be conservative when determining the value of a company because it can result in overstating and/or understating account balances. Management is given the responsibility of using their own judgment when it comes to the valuation of their company. This can potentially lead to overestimations to make the company and themselves look better. One job of financial analysts is to correct management s over or underestimation of business valuations. Shareholders and investors rely on accounting analysts to determine the true value of the business. Accounting analysis evaluates the quality of the firm s accounting. The first step in the accounting analysis is to identify principal accounting policies. This step is crucial because it measures critical factors and risks. The second step is assessing accounting flexibility. Not every firm has the same accounting flexibility because of conventions and accounting standards. Because GAAP allows for some flexibility, the third step is to evaluate the accounting strategy implemented under GAAP by the firm. Managers with 33

accounting flexibility have the ability to disclose as much or as little information as they would like. This can be problematic because managers can abuse this privilege by hiding the firm s true performance. The next step is to evaluate the quality of disclosure. Due to the power that managers hold when it comes to releasing information, this step focuses on the quality of information released. The fifth step is to identify potential red flags. This step is implemented when unexplained or odd accounting entries are made in financial statements. The analyst should examine these entries extremely closely. The last step is to undo accounting distortions. In the event that the firm s numbers in the financial statements are deceptive, it is the analyst s job to correct these numbers to the best of their ability. Key Accounting Policies When deciding a company s key accounting policies to use, it is important to base these off of the key success factors of the firm. The key success factors of Apache are economies of scale, industry growth and importance of product, derivative instruments and hedging activities. Competition in the oil exploration industry is high because it is basically impossible to differentiate their product. Companies in the oil industry try to achieve a competitive advantage through price and quality of product. By maintaining low costs, Apache achieves its biggest competitive advantage. GAAP allows flexibility as far as the information that managers can disclose, leaving room for misleading information being disclosed to shareholders and investors. This limited disclosure can make a company more appealing to these shareholders and investors and therefore lead to higher profit and overstated net income. Constant Growth Cash flow from operating activities increased but was offset by higher production costs due to increasing commodity prices, as well as Hurricanes Katrina and Rita, and increasing exchange rates with Canada. Fluctuating commodity prices are very common and are historically the primary reason for short-term changes in cash flow from operating activities. Sales volume changes also pose an effect to short-term cash 34

flow, but are obviously not as volatile as the fluctuating commodity price. Apache s long term cash flow from operating activities is not only dependent on commodity prices, but on reserve replacement and the level of costs and expenses required for continued operations. (Apache s 10-K, March 1, 2007) Constant growth relates to Apache s first key success factor, economies of scale, which in layman s terms means as the firm increases its scale of operations, long run costs per unit decline. By using the full cost method and therefore overstating yearly net income, it not only increases outside investment, but allows for the products costs to remain lower. This in turn keeps Apache competitive with the competition which helps ensure not only higher profitability in the future, but also a firm hold on their current market share with room to expand operations. By expanding operations at their current rate, the company is maximizing the benefits that come with economies of scale. Internal costs from years 2004-2006 have been capitalized in order to extend the costs over a longer period of time. Apache capitalized $146 million, $141 million and $107 million of these internal costs in 2006, 2005, and 2004 respectively (Apache Oil Corporation 2006 10-K). Apache uses funds from sales of proven reserves to reduce the balance left on capitalized assets. Unless a significant portion of the Company s proved reserve quantities in a particular country are sold (greater than 25 percent), proceeds from the sale of oil and gas properties are accounted for as a reduction to capitalized costs, and gains and losses are not recognized (Apache Oil Corporation 2006 10-K). Apache calculates depreciation, depletion, and amortization using the unit of production method every quarter. This depreciation method is useful because it calculates the amount of reserves used with a fixed rate, over the useful life of the reserve. The costs to be amortized include estimated future expenditures to be incurred in developing proved reserves as well as estimated dismantlement and abandonment costs, net of salvage value, that have not yet been capitalized as asset retirement costs (Apache Oil Corporation 2006 10-K). 35

Derivative Instruments and Hedging Activities Apache enters into derivative contracts to manage exposure to foreign currency and commodity price risk. Apache normally hedges around 10% of its operations and these derivatives take the form of contracts, future contracts, swaps or options. The oil and gas reference prices, on which the commodity derivative contracts are based, reflect various market indices that have a high degree of historical correlation with actual prices received by the Company for its oil and gas production (p. F-10, Apache 10-K, March 1, 2007). After tax, as a result of hedging activities, Apache gained an after-tax net of 83.5 million dollars. This acts as an insurance policy that is used to ensure that the company receives a certain price for a commodity and is extremely effective in creating stability within the firm and adding value. This accounting policy is relevant to Apache s key success factors because derivative instruments and hedging are necessary to ensure that even only 10% of the commodity will be sold at a certain price, locking in profit. Everyone is dependent upon oil, so there is always a demand, and with fluctuating demand comes the need for companies to likewise protect themselves from the resulting fluctuation in prices. Foreign Currency Risk As an American based company dealing with billions of dollars in assets overseas, it is important to note that the cash flow streaming to certain international operations is based on the U.S. dollar equivalent of cash flows measured in foreign countries. The functional currency is determined country by country based on relevant facts and circumstances of the cash flows, commodity pricing environment, and financing arrangements in each country (Apache Oil Corporation 2006 10-K). For example, in Australia, oil production is sold under U.S. dollar contracts while gas production is sold under fixed-price Australian dollar contracts. In Canada, the majority of oil and gas production is sold under Canadian dollar contracts, and the majority of costs incurred are paid in Canadian dollars. The North Sea production is sold under U.S. dollar contracts and the majority of costs incurred are paid in British pounds. 36

However, in Egypt all oil and gas production is sold for U.S. dollars and the majority of costs incurred are denominated in U.S. dollars. In Argentina revenues and expenditures are denominated in U.S. dollars but translated into Argentinean pesos at the then current exchange rate. No matter the unit of currency, whether the British pound, or Australian and Canadian dollars, it is very important to note that they are all converted into U.S. dollar equivalents based on the exchange rates on the day that the transaction takes place. An example of how volatile these translations affect the income statement, A 10 percent strengthening or weakening of the Australian dollar, Canadian dollar, British pound as of December 31, 2006, would result in a foreign currency net loss or gain of approximately 112 million (p. 44, Apache s 10-K, March 1, 2007). This statistic helps illustrate the importance of the insurance provided by hedging activities, as the 83.5 million dollars gained as a result of hedging would help negate the net loss resulting from a 10 percent weakening of the U.S. dollar. Use of Estimates The oil and gas industry is required by GAAP to have reliability among financial statements. This is important because an overestimation of reserves can increase the present value of long term cash flows coming from sales of petroleum products. This is something that could drive up the stock price if Apache knowingly overestimated their reserves. This is why reservoir sizes and contents are estimated by outside companies to ensure these numbers remain unbiased and not grossly overestimated. Post-Retirement Benefit Plans There are many retirement and deferred compensation plans offered by Apache. These include a 401(k) savings plan, a money purchase retirement plan, a non-qualified retirement/savings plan, pension plan, and postretirement benefit plan. In Apache s 410(k) plan, employees are given the option to contribute as much as 25% of their salaries, and Apache will match the contributions up to 6% of the employee s salary 37

(Apache Oil Corporation 2006 10-K). In 2006, Apache had 90 million dollars in benefit obligations for the pension plan. 4.7% is the discount rate that is applied to the pension benefits in 2006. Post-retirement benefits are discounted at a rate of 5.5%. Apache plans on contributing 6 million dollars to its pension plan and 402,000 dollars to its post-retirement benefits plan in 2007. In contrast, in 2007 Apache expects to pay out 822,000 dollars in pension benefits and 402,000 dollars in post retirement benefits to employees. Government restrictions are accounted for annually to adjust how much employee input is allowed. The non-qualified retirement/savings plan permits the delay of up to 50% of each employee s salary, and which accepts employee contributions and the Company s matching contributions in excess of the above referenced restrictions on the 401(k) savings plan (Apache Oil Corporation 2006 10-K). Apache s pension plan is not offered to recently hired employees and offers specific benefits based on their average salary and total years of service. The postretirement benefit plan provides medical benefits up to the age of 65, it is contributory with participant s contributions adjusted annually, and covers substantially all of Apache s US employees (Apache Oil Corporation 2006 10-K). Goodwill Goodwill is recorded as an intangible asset on the balance sheet. It usually comes from mergers and acquisitions when the buying company pays in excess of the book value of the company being bought out. It is an asset that does not contribute to helping the company receive cash flow. Having a large amount of assets being goodwill is not to a company s advantage even though it boosts their assets. Apache has goodwill on their books recorded at 189 million dollars. This is not a significant amount in comparison with their total assets of 24 billion. This is less than 1 percent of their total assets. 38

Conclusion With more firms manipulating numbers to make a company more attractive to investors, knowing how firms use accounting policies to dress their books is becoming more and more important. As with most firms, these accounting policies are chosen because they are the ones that help the firm better achieve their key success factors. Apache provides investors with relatively high levels of disclosure as compared with the rest of the industry. The level of disclosure in Apache s annual reports is helpful to the investor because it gives them a snapshot of the company and highlights the progression of many of the company s key success factors such as economies of scale and derivative instruments and hedging. Potential Accounting Flexibility Financial statements provide investors with the information needed to determine the value of a company. Investors need to be able to rely on the information given in the statements in order to make a more informed decision. There is a certain amount of flexibility within the GAAP system, giving companies room to stretch the truth to make the firm more attractive to investors. Below are the ways that Apache can be flexible while staying in line with GAAP regulations. Full Cost vs. Successful Efforts Methods Apache Oil Corporation uses the full cost accounting method when valuing their assets. Under this method, all costs are capitalized when drilling wells, successful or not. As opposed to operating expenses where expenses used to run a business are entered as they are incurred, capitalization is used to acquire long-term assets which results in the depreciation of the asset over its useful life. To better understand the upside to the full cost method, it is important to also understand the successful efforts method. Unlike the full cost method, the successful efforts method chooses to only amortize successful projects in contrast to expensing all successful and unsuccessful projects. According to Apache s most recent 10-K, The company capitalizes all 39

acquisition, exploration, and development costs incurred for the purpose of finding oil and gas reserves, including salaries, benefits, and other internal costs directly attributable to these activities (Apache Oil Corporation 2006 10-K). Why capitalizing is so important is because instead of taking out of the company s bottom line at one time, they are gradually expensed. This leads to a more inflated bottom line and resulting higher net profits on the income statement, which in turn makes the company more attractive to investors. Capital and Operating Leases Operating leases are contracts that allow a company to use an asset for a segment of its useful life. Operating leases do not transfer the title of an asset to another company, and is not capitalized. It is recognized on the income statement as an operating expense. No obligations are recognized on financial statements though. The operating lease is shown off the balance sheet not viewable to someone looking purely at financial statements. In a capital lease, the lease is recorded on the balance sheet as a liability similar to a mortgage. The lessee has benefits of ownership such as depreciation and tax write offs. Apache has operating and international leases. The company leases from governments, plots of land offshore controlled by the governments of different countries. The Company, through its subsidiaries, has acquired or has been conditionally granted exploration rights in Egypt, Australia, the North Sea and Argentina. In order to comply with the contracts and agreements granting these rights, the Company, through various wholly-owned subsidiaries, is committed to expend approximately $240 million through 2010 (Apache Oil Corporation 2006 10-K). Through operating leases, Apache has the right to explore for new oil acquisitions, and is not in contract for the next 3 years. In 2006, Apache paid 1.36 billion dollars in lease operating costs. This number has been steadily increasing from 865 million in 2004 to 1 billion roughly in 2005 and more in 2006 as stated above. This is due to all the 40

acquisitions that Apache has made in the past couple years. Apache has rented these areas to search for new oil and potentially expand their business. Apache also has leases for buildings, facilities, and equipment with various expiration dates through 2035, and has purchase commitments in Egypt for pipeline and gas plant construction totaling $390 million through 2008 (Apache Oil Corporation 2006 10-K). Conclusion Apache uses the flexibility within GAAP to give investors the most effective information needed to value the company. This flexibility allows managers to estimate the assets and liabilities, as well as chose what type of lease to use. This allows Apache to provide the most effective and accurate financial statements with good disclosure within. Actual Accounting Strategy Generally accepted accounting strategies allow companies to choose whether to make their financial statements appear aggressive, conservative, or both. Aggressive accounting overstates the company s net income, whereas conservative accounting understates net income. Firms will often use a mixture of both accounting strategies, however, after examining Apache s financial statements, it shows they use a mixture of both aggressive and conservative accounting. An example of Apache s aggressive accounting strategy would be their use of the full cost method. As aforementioned, this expenses all drilling projects gradually rather than letting the full brunt of their force affect net income. All projects, successful or unsuccessful are depreciated which is more aggressive because not only are they gradually taken out of net income, but also make it harder to see the ratio of successful to unsuccessful projects. This use of the full cost method is aggressive because it 41

overstates the net income and potentially makes the company more appealing to outside investors. Apache holds multiple operating leases, as do many other oil and gas companies. Apache s 2006 value of all operating leases totals a little over 1.3 billion. This is a relatively small number, which is disclosed in the 10-K, in comparison to their total assets. This shows analysts that Apache has a good level of disclosure, showing a conservative accounting approach, proving that Apache does use a mixed accounting strategy. Quality of Disclosure Managers have a choice in deciding how difficult or simple it is to determine the value of a company for the investors. This depends on the quality of information given in the financial statements. Ultimately, managers have the final say in what information is revealed, although accounting standards require a minimum amount of information necessary. Qualitative Analysis of Disclosure The information given to investors about a company should be relative and reliable information. This information should tell enough about the company to provide analysts with the information needed to value the company, as well as keep the information competitors would find beneficial concealed. It is crucial for the company to supply information that investors find trustworthy so they have confidence in the company s financial statements and the company as a whole. Apache does a good job of disclosing relevant information to investors. Not only do they supply relevant information, but everything we wanted to know about the company was found in the company s 10-K or annual report. 42

Pensions Apache discloses all of their information about pensions throughout their financial statements, making the company seem more credible. Information given on the financial statements about pension plan is important not only to employees, but also to investors and shareholders. This is important because managers can manipulate these numbers to make the company look better. Apache s 10-K provides adequate information for investors to successfully value the company. This is shown through the graphs with numerical values of the pension plans over the past 2 years, paragraphs explaining the distribution of employee salaries and the eligibility of employees for these pension plans. Apache also includes the total cost of their pension plan, which have increased steadily, for the past 3 years. As a whole, the information contained in Apache s financial statements is relevant and useful to investors. Environmental Issues Environmental concerns are important to investors when determining the value of an oil and gas company. The information that Apache discloses in their 10-K about their environmental concerns reassures investors that the company is adhering to all rules and regulations associated with protecting the environment. The Company, as an owner or lessee and operator of oil and gas properties, is subject to various federal, provincial, state, local, and foreign country laws and regulations to discharge of materials into, and protection of, the environment (Apache Oil Corporation 2006 10-K). Apache makes periodic checks of their reserves to make sure that they are in compliance with all stated laws. They maintain their reserves by checking them frequently to ensure they are in conformity with environmental regulations. The Company also conducts periodic reviews, on a company wide basis, to identify changes in its environmental risk profile. These reviews evaluate whether there is a probable liability, its amount, and the likelihood that the liability will be incurred (Apache Oil Corporation 2006 10-K). Apache is committed to continuously maintaining their reserves in order to keep up with ever changing environmental laws. All of this 43

information is clearly stated in the 10-K and is available for investors as well as the general public. Insurance Claims In case of natural disasters, insurance policy information gives investors peace of mind about the company s stability. Disclosure of this information helps investors know that a company is protected and the initial investment will be safe. For example, during hurricane Katrina, one of Apache s reserves was damaged. Apache has filed claims with OIL Insurance Ltd. Who provided Apache s first level of property damage insurance coverage ( OIL coverage ) (Apache Oil Corporation 2006 10-K). Not only does Apache have a first layer of insurance coverage, it also has a second layer for added protection. Insurance makes investors more confident in the company they are investing in, because in essence, their investment is safer with the insurance. Conclusion The information provided in Apache s financial statements is very thorough and conclusive. This information is crucial to investors, making them aware of the extra efforts of Apache to disclose all relevant information. Not only does this show Apache s commitment to its investors, but also its ethical responsibility. After reviewing Apache s 10-K, the information received satisfied all questions and concerns about the company. Quantitative Analysis of Disclosure Managers are provided with a certain amount of flexibility when producing financial statements for investors. GAAP allows this since they have standards for all industry s financial statements, and not all industries are the same. Managers can be tempted to inflate or deflate estimates in order to make their company look better to potential investors. The possibility of incorrect estimates should persuade investors and analysts take a close look at all financial statements and numbers. A considerable 44

change in numbers should alert investors and analysts to closely examine these changes. Two ways to successfully assess revenues and expenses are expense manipulation and sales manipulation diagnostics. Expense manipulation compares asset turnovers, cash flows, sales, accruals, and other expenses on a year to year basis. Sales manipulation compares net sales, cash from sales, accounts receivables, unearned revenues, and warranty liabilities also on a year to year basis. Analysts should look for any unusual increases or decreases in ratios to signal incorrect numbers. These numbers could show misleading estimates by managers when creating financial statements. Sales Manipulation Diagnostics Sales manipulation diagnostics is a valuable tool when searching for any inaccurate numbers in financial statements. Management has the ability to distort net income. This is done in two different ways. One is by overstating revenues; the other is understating expenses. Analysts or investors can also compare these ratios to those of their competitors to look for any unusually high or low ratios in relationship to their competitors. Below are the sales manipulation diagnostic ratios for Apache and its competitors, Devon, XTO, Occidental, and Anadarko. 45

Net Sales/ Cash From Sales The ratio of net sales to cash from sales consists of gross sales minus returns, discounts, and allowances divided by cash received from the sale. In this industry, there are not much, if any returns or discounts. There is allowance for doubtful accounts because whenever making sales on credit, it is a must to allow for bad debts. A favorable ratio is 1:1 because this means that the company is liquid, and doesn t accept credit sales. This ratio is hard to achieve. The full sale is not listed as cash until the full payment is received, making the company less liquid. The industry has maintained a ratio fairly consistent between 1:1 and 1:1.1. This shows that for the most part, companies in this industry try to keep less than 10 percent of their sales on credit. Approaching 2006, with the exception of Anadarko, the industry seemed to tolerate fewer sales on credit and therefore improved towards a 1:1 ratio. 46

Net Sales/ Net Accounts Receivable The ratio of net sales to net accounts receivable shows that Apache is consistently average within the industry. This shows that Apache s balance in accounts receivable is lower than their competitors, and their sales from accounts receivable have been consistently paid off. In 2006, Apache had a ratio of a hair under 5. This tells you that for every dollar of net sales, there is only about 20 cents in accounts receivable. Anadarko, Devon, and XTO s accounts receivable rations remained relatively constant throughout the 5 years, although they were much higher than Apache s. 47

Net Sales/ Inventory The ratio of net sales to inventory tells how well the company can turnover its inventory to produce revenue. There are only two companies out of Apache and its competitors that show inventory on their financial statements. This is due to the fact that the other companies do not report their reserves as an inventory. They will report it in other accounts such as a reserves account. Apache s ratio in 2006 tells us that it turned over its reported yearend inventory 25 times with the amount of sales achieved. Occidental s ratio of inventory turnover throughout the last 4 years has been relatively consistent. However, Apache s ratio made a sudden increase in 2003, remained stable for 2 years, and then almost returned to the 2002 level. The sudden decrease in 2005 is due to hurricanes Katrina and Rita, which caused a severe reduction in Apache s inventory and ability to produce petroleum. 48

Sales Manipulation Diagnostics Apache Net Sales/Cash from Sales Net Sales/Net Accounts Receivable Net Sales/Inventory 2002 2003 2004 2005 2006 1.05 1.03 1.06 1.07 1.03 4.85 6.57 5.65 5.16 4.89 23.44 33.36 33.75 35.57 25.20 XTO Net Sales/Cash from Sales Net Sales/Net Accounts Receivable Net Sales/Inventory 1.04 1.05 1.08 1.11 1.01 5.57 6.00 5.69 5.18 6.34 NA NA NA 123.73 66.40 Anadarko Net Sales/Cash from Sales Net Sales/Net Accounts Receivable Net Sales/Inventory 1.02 1.00 1.04 1.09 1.16 3.48 4.64 4.49 3.70 3.10 NA NA NA NA NA Devon Net Sales/Cash from Sales Net Sales/Net Accounts Receivable Net Sales/Inventory 1.04 1.04 1.04 1.02.98 6.75 7.77 6.88 6.78 7.59 NA NA NA NA NA Occidental Net Sales/Cash from Sales Net Sales/Net Accounts Receivable Net Sales/Inventory.80 1.00 1.00 1.02.99 6.72 8.01 4.87 4.65 5.31 18.91 18.89 19.96 20.39 21.40 49

Expense Manipulation Diagnostics Expense manipulation diagnostics are also an important tool when determining any discrepancies in financial statements. Analysts and investors can compare these ratios to determine if any of the ratios are unusually large or small in comparison to previous year s ratios or other competitors ratios within the industry. Below are the expense manipulation diagnostic ratios for Apache and its competitors, Devon, XTO, Occidental, and Anadarko. Sales / Assets Asset turnover is the ratio of sales divided by assets. This ratio essentially tells investors and analysts the sales which derived from a corporation s assets. Looking at the chart above, it shows that Occidental consistently has the highest asset turnover ratio. In the oil and gas industry this tells investors that Occidental gets the most from 50

their assets, which in this industry can mean having the most successful exploration and drilling. Apache s ratio is most in line with the industry norm as represented on the chart by their other three competitors. In 2006, Apache s ratio was approximately 0.3. This represents 30 cents in sales for every dollar of assets a corporation holds. The oil and gas industry is very dependent on commodity prices, and as the price of oil has increased over the past 4 years, it has increased the asset turnover ratio for the industry. In the last 2 years as corporations have spent more money on acquisitions, increasing their assets, it is normal to have a steady decline in the short term. This is represented by the declining ratio from 2005 to 2006. In the future, as these companies start to reap the benefits of their acquisitions, the ratio should start to increase again as it did from 2002 to 2005. 51

Cash Flows From Operating Activities/ Operating Income The ratio of cash flows from operating activities to operating income shows the relationship between the cash provided by operating activities to the amount of operating income. When a firm has a lower ratio they are more productive because the cash they receive is more from operating activities instead of things that are not their normal course of business. Starting in 2002, oil prices started rising which was increasing the cash flows from operating activities in relation to operating income. As oil prices reached their peak and started leveling off, there was not as much change in operating income and which caused this ratio to taper off steadily. 52

Cash Flows From Operating Activities/ Net Operating Assets The ratio of cash flows from operating activities to net operating assets shows the relationship between cash flows from operating activities to fixed assets, and property, plant and equipment. When a firm has a higher ratio, it means the firm is being productive by generating more income per fixed asset. In the oil and gas industry, most of the assets are capitalized, making the ratios relatively low. Once again, in 2002 oil prices jumped up and cash flows from operating activities increased. This balanced out the ratio to become positive and then taper back down slightly in 2005. This is due to oil companies investing in more acquisitions which increases net operating assets. Apache moved right along with the industry raising no red flags as to the questionability of Apache s reporting. 53

Expense Manipulation Diagnostics Apache Declining Asset Turnover Changes in CFFO/OI Changes in CFFO/NOA Total accruals/change in sales Devon Declining Asset Turnover Changes in CFFO/OI Changes in CFFO/NOA Total accruals/change in sales Anadarko Declining Asset Turnover Changes in CFFO/OI Changes in CFFO/NOA Total accruals/change in sales Occidental Declining Asset Turnover Changes in CFFO/OI Changes in CFFO/NOA Total accruals/change in sales XTO Declining Asset Turnover Changes in CFFO/OI Changes in CFFO/NOA Total accruals/change in sales 2002 2003 2004 2005 2006.27.34.34.39.33 -.61.25.39.25 -.0046 -.07 0.12 0.04 0.07 -.001 2.14 -.48 -.35.10 -.15.27.27.31.35.30 -.11.55.51.42.25 -.03.10.08.11.07 -.98 -.37 -.61 -.47 9.57 0.21 0.25 0.3 0.31 0.17-0.93 0.46 0.07 0.27 0.15-0.07 0.05 0.01 0.05 0.02 -.17 -.66 -.34 -.13 -.003.44.51.51.56.55-0.47 0.64 0.31 0.28 0.24 -.02.05.03.05.03 -.005.05.22.29.60.31.33.32.36.36-0.15 0.60 0.46 0.45 0.28 -.022 0.09 0.08 0.10 0.07 4.9 -.77 -.39 -.08 -.18 54

Conclusion The inconsistencies within the oil and gas industry are usually explainable. Examples of this are new acquisitions and natural disasters. Even though these are usually explainable, they need to be thoroughly examined by analysts and investors to insure accurate accounting practices. Generally, Apache follows the industry averages for the sales and expense manipulation diagnostic ratios. Even though this industry has the potential to be inconsistent, all of the companies examined proved to be stable. Financial statements should not be read as fact; the analyst should question the information given to make an unbiased evaluation of the company. Potential Red Flags When looking over graphs and ratios of the industry, there is nothing that significantly catches the eye concerning Apache. We were mainly looking for outlying distortions in the graphs pertaining to Apache. Apache s data was in line with the named competitors throughout the industry. The only thing that was noticeable was the Net Sales/Inventory ratio. Apache and Occidental did have inventories at the end of the year for 2002 through 2006 while other companies researched had no inventories. This could possibly mean that these two companies produced an excess amount of oil and gas that did not sell off completely. Obviously, this isn t necessarily a good thing because in an ideal situation, you sell off everything you produce keeping inventory to a minimum. This could mean that Apache doesn t have as good of ties with buyers as other companies throughout the industry, and the buyers already had filled their purchase quotas with other producers petroleum products. What stood out the most is the 10 point increase in the Net Sales/Inventory ratio between 2002 and 2003, and the 10 point decrease in the ratio between 2005 and 2006. When the ratio goes up, it means that inventory has decreased. Likewise, when inventory goes up, the Net 55

Sales/Inventory ratio decreases. Looking back over the past year this can be attributed to sky high gas prices along with disasters such as Hurricane Katrina. Studying the data shows that as gas prices stayed relatively stable between 2003 and 2005, the ratio stayed steady. However as gas prices peaked in the past year and a half, there has been less demand and as a result an increase in Apache s inventory. Once again, Apache does a good job of disclosing information in the notes to the financial statements. They give detailed data regarding operating leases, when and how much is due in every year into the future. Discount rates for all of their long term debt were disclosed as well. Coming Undone (Undo Accounting Distortions) The amount of information contained in Apache s financial statements gives investors all relevant and necessary information to value the company. After examining Apache s 10-K, we have determined that their numbers are reliable and there are no accounting distortions that need to be corrected. Financial Analysis, Forecast Financials, and Cost of Capital Estimation Financial Analysis When comparing firms to each other, one consistent way of comparing them to each other is to use financial ratios. Investors and analysts have come up with many ratios to measure the success of companies. Success can be measured in many different ways using different ratios. The most common types of ratios are liquidity ratios, profitability ratios, and capital structure ratios. In this part of the analysis, we will view and discuss many of these ratios and what they portray about the firm and how it stands against its competitors within the industry. Then we will discuss the forecasting of financials for Apache and how we came to estimate its future performance. 56

Liquidity Analysis Liquidity ratios measure a firm s ability to meet its short term liability obligations. Lenders and creditors often look at these ratios to determine whether companies are credit worthy, what rates to lend at, and other loan terms when borrowing money. The more liquid a firm is, the more likely banks and other lenders are to loan money because the firm appears to be able to generate money quickly compared to its short term debt. Current Ratio The current ratio describes the company s ability to meet its short term debt obligations immediately if the situation calls for it. The situation would involve the 57

company having current debt suddenly due and to pay it off the company would use its current assets to do so either by using cash or selling off other current assets. The current ratio compares a company s current assets to its current liabilities. If the ratio was 2:1, that would mean the company has 2 dollars in assets for every one dollar in liabilities. This ratio is good, and as the first number keeps going up, it means the ratio gets better and better. In the independent oil and gas industry, Apache stands around normal compared to its competitors. Current ratios in the industry range from.6 to 1.6 over the past five years. Apache has steadily declined over the past five years along with a few other companies. This could be due to the way business has been over the past five years and due to large industry growth. Since companies know business is growing, they might be willing to take on more debt to acquire more prospects in the field knowing that they will be able to pay it off with ease. 58

Quick Ratio The quick ratio compares the same things as the current ratio except that it excludes inventory out of the current assets portion of the ratio. By doing this, it gives a more realistic picture of how quick a company could pay off short term debts and payables. This is because inventory is sometimes hard to sell off. Once again, Apache stands about normal or slightly lower than the industry when comparing quick asset ratios over the last five years. They are ranging from around.4 to about 1.3 on the upper end. Obviously, anything below 1 is not ideal because there are fewer assets than liabilities. Then again, it is hard to judge these companies against each other when many of the companies do not have inventories on their balance sheets, or at least not for all five years. 59

Receivables Turnover The Account Receivables Turnover ratio represents the relationship between a company s net sales (or Revenue) and its accounts receivables. The higher the ratio the more efficiently the company either collects its accounts receivables or operates on a cash basis. In our case in 2006 Apache s turnover ratio is 5.02; this means that for every one dollar of credit, Apache generated $5.02 in revenue. For Apache and our four competitors you can see that they all have around the same turnover ratios for the 5 year period for which we sampled data and graphed. If you look at the graph you can see that after 2003 each company s turnover ratio began to decline. For Devon, XTO, and Occidental the ratio increased after 2005. For Apache and Anadarko however, the ratio continues to decline. One of the possible explanations for this decline in turnover ratio is that since the petroleum and natural gas industries 60

have been growing rapidly since 2002, they have been increasing their liabilities and henceforth are using more credit than in previous years. Day Sales Outstanding Days sales outstanding measures how long it takes for a company to collect their accounts receivables. Obviously in this case a lower number is better because it means a company is collecting their receivables in a more timely fashion. Our ratios represent the number of days it takes to recover a company s receivables versus the number of times in a year that the receivables are turned over. Again Apache s data is right in the middle of our five company s data. This shows that Apache is doing a fairly decent job of collecting their accounts receivables in a timely manner. Apache s average days outstanding over the past 5 61

years are right around 65. This means that it takes around 65 days to collect on our accounts receivables. This is right in line with the industry average. Inventory Turnover Inventory turnover is a ratio that measures and describes the connection between a company s cost of goods sold in a year and its inventory. If the inventory is 10000 and cost of goods sold is 10000, then the ratio is 1 meaning that they only bought inventory once during the year and sold all of it. Having inventory on hand ties up money that can be used for other investments and opportunities. So, you want to have inventory turning over many times within a year but not too many times because then you probably don t have enough inventory on hand when needed. 62

Apache s inventory turnover seems to be in line with the companies in the industry that have inventory. Apache, Devon, and Occidental are the only companies which have held inventories over the past five years. It is difficult to measure inventory turnover in the oil and gas industry because most everything that is produced in this industry is sold before or while it is being produced; hence there is not much, if any, inventory on hand. Days Supply of Inventory Days supply of inventory measures the amount of days that it takes to completely sell off one batch of inventory. It is the first half of going through the cash to cash cycle and going through the process of collecting cash back to the firm. Once again, it is really difficult to even apply this ratio to the oil and gas industry because so many companies do not keep inventory on hand. Of the companies that do have inventory, Apache seems to be right in line with Occidental. Devon was the outlier 63

because it only had inventory for two years out of the five year span. As talked about earlier in our valuation of Apache, having inventory in this industry is probably not a good sign. There is obviously a reason as to why not the entire product produced was sold off. Maybe relations between Apache and their buyers aren t as good as the rest of the industry s relations with buyers resulting in Apache having to work harder to sell off their product. Buyers could have also already met their purchase quotas. Either way, Apache has consistently maintained a sufficient level of inventory over the five year stretch which raises eyebrows. The money merry-go-round determines the amount of time it takes for money to go out and then come back into the company. Keeping track of this is beneficial for the company because it is also a measure of efficiency. 64

Working Capital Turnover Working capital turnover is equal to Sales / (Current Assets-Current Liabilities). In other words working capital turnover is the relationship between sales and the money on hand that is used to fund operations. Though the higher working capital turnover you have the better, it is obvious when looking at Apache s data that this ratio is not imperative to running a successful corporation. Not only is Apache s working capital turnover highly sporadic, but in 2005 it is -300. This means that for every dollar of working capital Apache had in 2005, it lost $300. This is not necessarily correct however as in 2005 Apache made some major acquisitions which caused its current liabilities to basically serve as a severe outlier in comparison to the rest of their data. Apart from a few years of negative turnover, the average for our company and competitors is right around 10-15. This means that for every dollar of working capital, the industry averaged about 10-15 dollars in sales. 65

Conclusion Apache s liquidity stands with the industry on average except for the working capital turnover and the fact that Apache has inventory, which only Occidental has as well. The atrocious -300 working capital ratio in 2005 is mainly attributed to Apache s acquisitions which sent their current liabilities skyrocketing. Profitability Analysis Profitability analysis is composed of six ratios: gross profit margin, operating profit margin, net profit margin, asset turnover, return on assets, and return on equity. The objectives of these ratios are to evaluate four different important factors that are related to profits. These factors are operating efficiency, asset productivity, rate of return on assets, and rate of return on equity. Gross profit margin, operating profit margin, and net profit margin are necessary to measure a firm s operating efficiency. Asset turnover, return on assets, and return on equity are also necessary for measuring a firm s asset productivity, return on equity, and return on assets. 66

Gross Profit Margin The gross profit margin is found by dividing gross profit for the year by the total amount of revenue for the year. Gross profit is found by subtracting cost of goods sold from the total amount of revenue. The gross profit margin ratio is given in a percentage and shows what is left from revenues after deducting cost of goods sold. A higher percentage is better when looking at the gross profit margin and is a clear indication of the financial health of the company. Even though Apache s gross profit margin is considerably lower than its competitors we can see that it has been growing with the rest of the industry. Keeping pace with the rest of the industry is a good sign of the health of Apache. We attribute the lower percentage to the size of Apache compared to its competitors. 67

Operating Profit Margin The operating profit margin is found by dividing operating profit for the year by sales for the year. This ratio shows what is left over from revenues after paying the companies variable costs. The higher the operating profit margin the more efficiently the company is running. Apache has been very good at efficiently producing their products and keeping half of their revenues as profit. Apache is consistently at the top of the industry when it comes to operating efficiency. They did have a decrease in their operating profit margin in the last year after steady growth for the four years prior. This decrease is consistent with the industry as Anadarko and Devon both had decreases of the same magnitude. 68

Net Profit Margin Net profit margin is found by dividing net income for the year by sales for the year. Net income is the amount of money left over from revenues after subtracting costs and expenses. Net profit margin shows how much money the company actually keeps from the revenues they produce. The higher the percentage the more money the company is keeping from their revenues. Apache had been at the top of the industry for the years prior to 2006. In the last year Apache had a decrease in its net profit margin after four years of consistent growth. This shows that Apaches costs have increased over the last year. This decrease is consistent with many in the industry as Occidental also had a decrease and Devon s growth slowed. 69

Asset Turnover Asset turnover is computed by dividing sales for the year by total assets at the end of the year. This ratio shows how well a company is generating sales compared to the amount of assets they hold. It is also a good indicator at how efficiently their assets are being used. A higher percentage is better and shows a higher level of efficiency. Apache had a decrease in its asset turnover in the last year after peaking in 2005 at 0.39. This decrease is consistent with the rest of the industry as Apaches competitors all had decreases except XTO whose growth slowed. Up until last year Apache had been in the middle of the mix with the rest of the industry and had been growing at a steady rate. This decrease should not be surprising as the rest of the industry was moving in the same direction. We also believe that the large amount of acquisitions Apache had directly affected their asset turnover. 70

Return on Assets The return on assets ratio is computed by dividing net income by the previous year s total assets. Return on assets is affected by asset turnover and the net profit margin. The ratio tells that with every one dollar of assets used, the company is generating that much net income, so the bigger the ratio the better. In 2005, XTO s return on assets ratio declined to below one percent because for as many assets that were being used, they were producing very little net income. Also, Occidental s return on assets ratio rose quite rapidly, because their net income doubled from 2003 to 2005. The other company s ratios do not have as large of jumps or falls as the others. This is because for the assets those companies used or sold, they still produced enough net income. 71

Return on Equity Return on equity is found by dividing net income for the year by total owner s equity of the previous year. This ratio measures the profitability of the shareholder s prospective. It shows that for every one dollar of owner s equity, the company has that much net income, so the bigger the ratio, the better. Return on equity is influenced by the profit margin, asset turnover, and debt to equity ratios. In 2005, XTO s return on equity greatly declined, because its net income drastically fell. The other company s return on equity ratios remain somewhat steady compared to XTO. 72

Conclusion Apaches profitability looks to be right in line with the rest of the industry. For the years 2002 through 2005 Apache s profitability had been growing at a steady rate. Last year was the first year in the last five that they have shown a decrease in all of the ratios associated with profitability. We attribute this decline to the large amount of assets that came with their acquisitions over the past year. CAPITAL STRUCTURE ANALYSIS The capital structure of a firm shows which portion of the firm is financed by debt and which portion is financed by equity. These portions are all shown on the balance sheet in the financial statements. It is important to be able to service all of the debt a company owes compared to the amount of equity outstanding. It is imperative to maintain a good balance of debt to equity as well to be versatile in changing economic conditions. Times interest earned, Debt Service Margin, and the debt to equity ratio measure the credit risk to which a company is exposed, whether or not income from operations is able to cover interest charges, and the ability of the company s cash from operations to cover the annual installment payments on the principals of the company s long-term liabilities. 73

Debt to Equity Debt to equity is computed by dividing a company s total liabilities by its total owner s equity. This ratio is a sign that there could be the possibility that interest and debt repayment cannot be fulfilled by the company s cash flows. So companies should pay special attention to this ratio in order to stay away from potential credit risk. All of the industry seems to be in the range of.5 to 1.5 in the past five years. This keeps a pretty reasonable level of debt to equity. As the ratio goes above 1, there is more debt and below 1; more equity. Apache s ratio has been the steadiest since 2002 at just under 1 showing Apache s ability to balance their financing between debt and equity, keeping them both relatively steady. 74

Times Interest Earned Times interest earned is calculated by dividing a company s income from operations by its interest expense. Before there can be any profits to the stockholders of a company, that company s interest expense must be covered by income from operations. Time interest earned shows that for every dollar of interest expense a company has, they are producing that much more income from operations to cover the expense. The reason that XTO s times interest earned ratio in 2005 is zero, is because they did not have an interest expense in that year, so the ratio could not be computed. Apache continues to lead the industry on average for times interest earned. Over the past five years, they have been the most consistent of the five studied competitors. Not only is Apache making more money for each dollar of interest expense, but they are the only company to have the dollars earned per dollar of interest expense increase each year since 2002. 75

Debt Service Margin Debt to Service Margin The debt service margin is an explanation of how well a company is able to cover their debt with the cash acquired from operations. The industry average is relatively low with the exception of XTO. Since 2003, most of the companies are at about the same debt to service margin which means that is the norm for the industry. Apache is in the industry norm area. One reason the industry average is so low is because many of these companies in the past 5 years or so have made large acquisitions and are having to pay them off. These acquisitions will most likely pay off in the future and the low debt to service margin is most likely temporary and should not be looked upon as strictly poor performance. 76

Conclusion When looking over the capital structure graphs, Apache is in a pretty good state as compared to the rest of the oil and gas industry. They have maintained a good debt to equity ratio. Their times interest earned has been no less than stellar compared to the rest of the industry, and the debt to service margin is right along with most of their competitors. IGR/SGR Analysis IGR as well as SGR are important ratios because they tell investors valuable information about the growth of a company. The Internal Growth Rate, or IGR, is the amount of growth that the company can sustain internally without having to seek outside financial assistance. On the other hand the Sustainable Growth Rate, or SGR, is the amount of growth a company can sustain without borrowing more money. Internal Growth Rate Apache s IGR is much lower than the industry average IGR. This is an indicator that Apache has trouble financing projects with funds only generated within the company. This shows that Apache is using outside sources to aid in their asset acquisition as well as project undertakings. This could possibly be troublesome for the company, because a good balance between internal and external funding is favorable. Sustainable Growth Rate Apache s SGR is also much lower than the industry average SGR. This indicates that Apache is borrowing a lot of money to fund its asset acquisiton and projects. This is not favorable because in order for Apache to grow, they will have to borrow significant funds to sustain their growth rate. Once Apache has finished its mass expansion and acquisitions, the SGR as well as the IGR should be more on target with the industry averages because they will be able to generate their own funds. 77

IGR/SGR The IGR and SGR are important because they tell potential investors the limit to potential growth. After reaching this cap, the company cannot continue to grow without outside financial help. This is unattrative because they are not generating enough revenue within the company. Companies who increase debt to expand and grow, decrease their future profits because they have to repay that debt. A large IGR and SGR, unlike Apache s, tells investors the company is set to do well in the future. In Apache s case the low IGR and SGR are indicators the company is expanding and 78

acquiring more reserves. When the acquisitions of these reserves are complete, Apache will have higher IGR and SGR similar to that of the industry averages. Financial Statement Forecast Financial statement forecasting predicts a firm s future productivity by using past financial statements provided by the 10-K. It is a process that measures valuation in the future for a particular firm. Apache s income statement, balance sheet, and statement of cash flows provided the basis for our predictions. For the income statement, the forecasting was primarily based on assumptions provided by past growth rates, as well as industry growth rates. The balance sheet was forecasting was based off of the certain liquidity ratios as well historical growth rates. The most influential ratios when forecasting include current ratios, inventory turnover, accounts receivable turnover, and asset turnover. Manipulation diagnostics served as the main forecasting tool for the statement of cash flows. The primary assumption comes from CFFO, the basis for the entire statement of cash flows. The manipulation diagnostics that we used include CFFO/OI, CFFO/NI, and CFFO/Sales. Income Statement Analysis In order to forecast the income statement, we divided each item on the income statement by sales in order to get a common size income statement. Although the information overall was useful, there were fluctuations due to a large increase in assets as well as the effects of natural disasters. The 2005 hurricane season set many records and caused unprecedented damage to the energy industry. Most of the damage was due to Hurricane Katrina (landfall on Aug. 29) and Hurricane Rita (landfall on Sep. 24). These hurricanes not only destroyed or damaged production facilities in the Central Gulf of Mexico, they also damaged critical facilities on land (www.apachecorp.com). In 2004, Apache made a large acquisition in the North Sea which greatly increased their assets as well as their reserves. This acquisition was a 79

major one for Apache because it is supposed to begin exploration drilling in 2006. These events led us to forecast the income statement based on historical growth rates rather than Apache s growth rate between 2005 and 2006. The growth rate between 2005 and 2006 was so large due to the acquisitions; there was no way that Apache could sustain this growth rate over a long period of time. The industry growth rate seemed to produce more conservative forecasts. The industry average includes Apache as well as, XTO, Occidental, Anadarko, and Devon Energy Corporations. Every item on the income statement that showed consistency was forecasted out for 10 years. The industry average is 9.5%, and we felt a lower more conservative growth rate was appropriate because of the setbacks of recent hurricanes. We felt a 7% growth rate was suitable for Apache s revenue. Due to Apache s recent acquisitions, their revenue has the ability to grow at a constant 7% rate per year. From 2006 to 2007, revenue grew $580,215. The growth rate for XTO Energy was 27.4%, making the industry average unusually high. Because of this, we felt a 7% growth rate would be more realistic for Apache. This high rate was because XTO acquired many more reserves than competitors in the industry. All of the remaining forecasted line items were determined by industry averages as well as Apache s growth rates. We took into account any large jumps in industry averages in order to forecast in a conservative manner. Because we took the conservative approach, we believe that our forecasts are realistic and show steady growth over the next 10 years. 80

APACHE CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED OPERATIONS Actual Financial Statements Forecast Financial Statements 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 For the Year Ended December 31, 2002 2003 2004 2005 2006 (In thousands, except per common share data) REVENUES AND OTHER: Oil and gas production revenues 2,559,748 4,198,920 5,308,017 7,457,291 8,074,253 Gain on China divestiture - - 173,545 Other 125 (8,621) 24,560 126,953 40,981 Total Revenue 2,559,873 4,190,299 5,332,577 7,584,244 8,288,779 8,868,994 9,489,823 10,154,111 10,864,898 11,625,441 12,439,222 13,309,968 14,241,666 15,238,582 16,305,283 OPERATING EXPENSES: Depreciation, depletion and amortization 843,879 1,073,286 1,222,152 1,415,682 1,816,359 Asset retirement obligation accretion - 37,763 46,060 53,720 88,931 International Impairments 19,600 12,813 Lease operating costs 457,903 699,663 864,378 1,040,475 1,362,374 Gathering and transportation costs 38,567 60,460 82,261 100,260 104,322 Severance and other taxes 67,309 121,793 93,748 453,258 553,978 General and administrative 104,588 138,524 173,194 198,272 211,334 China litigation provision 71,216 Financing costs: Interest expense 155,667 169,090 168,090 175,419 217,454 Amortization of deferred loan costs 1,859 2,163 2,471 3,748 2,048 Capitalized interest (40,691) (52,891) (50,748) (56,988) (61,301) Interest income (4,002) (3,290) (3,328) (5,856) (16,315) Total Operating Expenses 1,644,679 2,259,374 2,669,494 3,377,990 4,279,184 4,707,102 5,177,813 5,695,594 6,265,153 6,891,669 7,580,835 8,338,919 9,172,811 10,090,092 11,099,101 Operating Income 71,315 857,639 1,440,931 2,790,572 2,193,236 2,394,628 2,562,252 2,741,610 2,933,523 3,138,869 3,358,590 3,593,691 3,845,250 4,114,417 4,402,426 PREFERRED INTERESTS OF SUBSIDIARIES... 16,224 8,668 INCOME BEFORE INCOME TAXES 898,970 1,922,257 2,663,083 4,206,254 4,009,595 Provision for income taxes 344,641 827,004 993,012 1,582,524 1,457,144 INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 554,329 1,095,253 1,670,071 2,623,730 2,552,451 Cumulative effect of change in accounting principle, net of income tax 26,632 (1,317) NET INCOME 554,329 1,121,885 1,668,754 2,623,730 2,552,451 2,483,318 2,657,150 2,843,151 3,042,172 3,255,124 3,482,982 3,726,791 3,987,666 4,266,803 4,565,479 Preferred stock dividends 10,815 5,680 5,680 5,680 5,680 INCOME ATTRIBUTABLE TO COMMON STOCK 543,514 1,116,205 1,663,074 2,618,050 2,546,771 BASIC NET INCOME PER COMMON SHARE: Before change in accounting principle $1.83 $3.38 $5.10 $7.96 $7.72 Cumulative effect of change in accounting principle $0.00 Principle $0.08 $1.83 $3.46 $5.10 $7.96 $7.72 DILUTED NET INCOME PER COMMON SHARE: Before change in accounting principle $1.80 $3.35 $5.04 $7.84 $7.64 Cumulative effect of change in accounting principle Principle $0.08 ($0.01) 81 $1.80 $3.43 $5.03 $7.84 $7.64 Actual Financial Statements Industry

Common Size Income Statement Actual Financial Statements 2002 2003 2004 2005 2006 AVG 05-06 AVG REVENUES AND OTHER: Oil and gas production revenues 100.00% 100.21% 99.54% 98.33% 97.41% 99.10% 97.87% Gain on China divestiture 0.00% 0.00% 0.00% 0.00% 2.09% 0.42% 1.05% Other 0.00% -0.21% 0.46% 1.67% 0.49% 0.49% 1.08% Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% OPERATING EXPENSES: Depreciation, depletion and amortization 32.97% 25.61% 22.92% 18.67% 21.91% 24.42% 20.29% Asset retirement obligation accretion 0.00% 0.90% 0.86% 0.71% 1.07% 0.71% 0.89% International Impairments 0.77% 0.31% 0.00% 0.00% 0.00% 0.21% 0.00% Lease operating costs 17.89% 16.70% 16.21% 13.72% 16.44% 16.19% 15.08% Gathering and transportation costs 1.51% 1.44% 1.54% 1.32% 1.26% 1.41% 1.29% Severance and other taxes 2.63% 2.91% 1.76% 5.98% 6.68% 3.99% 6.33% General and administrative 4.09% 3.31% 3.25% 2.61% 2.55% 3.16% 2.58% China litigation provision 0.00% 0.00% 1.34% 0.00% 0.00% 0.27% 0.00% Financing costs: Interest expense 6.08% 4.04% 3.15% 2.31% 2.62% 3.64% 2.47% Amortization of deferred loan costs 0.07% 0.05% 0.05% 0.05% 0.02% 0.05% 0.04% Capitalized interest -1.59% -1.26% -0.95% -0.75% -0.74% -1.06% -0.75% Interest income -0.16% -0.08% -0.06% -0.08% -0.20% -0.11% -0.14% Total Operating Expenses 64.25% 53.92% 50.06% 44.54% 51.63% 52.88% 48.08% PREFERRED INTERESTS OF SUBSIDIARIES... 0.63% 0.21% 0.00% 0.00% 0.00% 0.17% 0.00% INCOME BEFORE INCOME TAXES 35.12% 45.87% 49.94% 55.46% 48.37% 46.95% 51.92% Provision for income taxes 13.46% 19.74% 18.62% 20.87% 17.58% 18.05% 19.22% INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 21.65% 26.14% 31.32% 34.59% 30.79% 28.90% 32.69% Cumulative effect of change in accounting principle, net of income tax 0.00% 0.64% -0.02% 0.00% 0.00% 0.12% 0.00% NET INCOME 21.65% 26.77% 31.29% 34.59% 30.79% 29.02% 32.69% 82

Balance Sheet Analysis In order to accurately determine the future success of Apache, we began by creating a common size balance sheet. This gave us an idea of how Apache preformed in comparison the industry. By using industry averages, we were able to have a point of reference when comparing the numbers to Apache. The results gave us a better idea of which ratios would give the best estimations in forecasting. When creating our common size balance sheet, we compared all of the assets portion s line items to total assets to base our estimations. The industry average did not seem reliable because there is little consistency within the oil industry. Based on this, we decided to use our own growth rate to remain consistent with Apache s acquisitions and losses from natural disasters. We fist decided to forecast out total assets, and then determine what portions should go to current and non current assets. Our asset turnover ratio was a consistent.34 through the past 5 years. Due to the consistency, we decided to use this number when forecasting out total assets. Total assets were forecasted out by dividing the already forecasted sales from the income statement by our asset turnover percentage. With our reliable forecasted total assets, we then determined the amount of total assets that should be allotted into total current and non current assets. Current assets were forecasted out using a 9.5% growth rate, which is on target with the industry average. This industry average is consistent with inventory and accounts receivable forecasts. Accounts receivable was forecasted using the accounts receivable turnover ratio. We used our forecasted sales from the income statement as a basis for the forecasting. Accounts receivable turnover was 5.1 because it was the average of the last two years. Forecasted sales divided by a consistent 5.1 gave us the most reliable forecast. For inventory, we used a inventory turnover rate of 7. This was the average of the last two years, and seemed to be a good fit for the company. The reason we based forecasting off the last two years was because of several hurricanes as well as acquisitions which made the ratios fluctuate greatly. The past two years 83

proved to be a more stable benchmark for our company. Property, plant, and equipment was forecasted at a consistent percentage as well as total non current assets. This was based on the percentage left over from total assets minus total current assets. For the equity section of the balance sheet, we first forecasted out the retained earnings section. We did this by adding the previous year s retained earnings to that year s net income and then subtracting out the dividends paid. Stockholder s equity was then forecasted out based on the retained earnings. We took the previous year s equity and added that year s retained earnings less the previous year s retained earnings. We then found liabilities based on assets equals total liabilities plus total stockholder s equity. This equation states that liabilities must be equal to equity subtracted from assets and therefore, total liabilities should balance. We forecasted current liabilities using the current ratio. Because of Apache s rapid growth in the past few years, long-term debt had a consistently high percentage. Based on this, we determined this percentage should be used to forecast because of our rapid growth plan. Once we found current liabilities, we were able to determine the amount of noncurrent liabilities. 84

APACHE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET Actual Financial Statements Forecast Financial Statements 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 December 31, 2002 2003 2004 2005 2006 ASSETS (In thousands) CURRENT ASSETS: Cash and cash equivalents 51,886 33,503 111,093 228,860 140,524 Receivables, net of allowance 527,687 639,055 939,736 1,444,545 1,651,664 1,739,018 1,860,750 1,991,002 2,130,372 2,279,498 2,439,063 2,609,798 2,792,483 2,987,957 3,197,114 Inventories 109,204 125,867 157,293 209,670 320,386 1,266,999 1,355,689 1,450,587 1,552,128 1,660,777 1,777,032 1,901,424 2,034,524 2,176,940 2,329,326 Drilling advances 45,298 58,062 82,889 146,047 78,838 Prepaid assets and other 32,706 42,585 57,771 132,955 139,756 159,103 Total Current Assets 766,781 899,072 1,348,782 2,162,077 2,490,271 2,726,847 2,985,897 3,269,557 3,580,165 3,920,281 4,292,708 4,700,515 5,147,064 5,636,035 6,171,458 PROPERTY AND EQUIPMENT: Total PP&E 8,465,585 11,260,085 13,860,359 16,791,340 21,346,252 21,559,715 21,775,312 21,993,065 22,212,995 22,435,125 22,659,477 22,886,071 23,114,932 23,346,081 23,579,542 OTHER ASSETS: Goodwill, net 189,252 189,252 189,252 189,252 189,252 Deferred charges and other 38,233 67,717 104,087 129,127 282,400 Total Non-Current Assets 227,485 256,969 293,339 318,379 471,652 650,880 898,214 1,239,535 1,710,559 2,360,571 3,257,588 4,495,472 6,203,751 8,561,177 11,814,424 Total Assets 9,459,851 12,416,126 15,502,480 19,271,796 24,308,175 24,378,762 26,085,275 27,911,244 29,865,031 31,955,584 34,192,475 36,585,948 39,146,964 41,887,252 44,819,359 Working Capital 234,546 78,694 65,891 (24,487) (1,321,341) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable... 214,288 300,598 542,074 714,598 644,889 Accrued operating expense... 47,382 72,250 80,741 66,609 70,551 Accrued exploration and development... 146,871 212,028 341,063 460,203 534,924 Accrued compensation and benefits... 32,680 56,237 83,636 125,022 127,779 Accrued interest... 30,880 32,621 32,575 32,564 30,878 Accrued income taxes... 44,256 18,936 78,042 120,153 2,133 Oil and gas derivative instruments... - 63,542 21,273 Current Debt 274 1,802,094 Asset retirement obligation 93,557 376,713 Derivative instruments 256,115 70,128 Other... 15,878 64,166 103,487 317,469 151,523 Total Current Liabilities 532,235 820,378 1,282,891 2,186,564 3,811,612 3,895,495 4,265,567 4,670,796 5,114,522 5,600,402 6,132,440 6,715,021 7,352,949 8,051,479 8,816,369 LONG-TERM DEBT...(notes)... 2,158,815 2,326,966 2,588,390 2,191,954 2,019,831 2,221,814 2,443,996 2,688,395 2,957,235 3,252,958 3,578,254 3,936,079 4,329,687 4,762,656 5,238,921 Total Long Term Liabilities 1,407,895 2,735,984 3,426,778 4,352,063 5,285,679 5,814,247 6,395,672 7,035,239 7,738,763 8,512,639 9,363,903 10,300,293 11,330,322 12,463,355 13,709,690 PREFERRED INTERESTS OF SUBSIDIARIES... 436,626 - - - - Total Liabilities 4,535,571 5,883,328 7,298,059 8,730,581 11,117,122 8,529,100 7,376,713 6,131,323 4,788,271 3,342,573 1,788,896 121,534 (1,665,619) (3,579,097) (5,625,890) COMMITMENTS AND CONTINGENCIES (Note 11) SHAREHOLDERS' EQUITY: Preferred stock, no par value, 5,000,000 shares authorized -- Series B, 5.68% Cumulative Preferred Stock, 100,000 shares issued and outstanding... 98,387 98,387 98,387 98,387 98,387 Common stock, $0.625 par, 430,000,000 shares authorized, 332,509,478 and 310,929,080 shares issued, respectively... 194,331 207,818 209,320 210,623 212,365 Paid-in capital... 3,427,450 4,038,007 4,106,182 4,170,714 4,269,795 Retained earnings... 1,427,607 2,445,698 4,017,339 6,516,863 8,898,577 11,557,186 14,416,086 17,487,445 20,784,284 24,320,534 28,111,102 32,171,937 36,520,107 41,173,872 46,152,773 Treasury stock, at cost, 8,012,302 and 8,422,656 shares, respectively... (110,559) (105,169) (97,325) (89,764) (256,739) Accumulated other comprehensive loss... (112,936) (151,943) (129,482) (365,608) (31,332) Total Shareholders Equity 4,924,280 6,532,798 8,204,421 10,541,215 13,191,053 15,849,662 18,708,562 21,779,921 25,076,760 28,613,010 32,403,578 36,464,413 40,812,583 45,466,348 50,445,249 Total Liability and Equity 9,459,851 12,416,126 15,502,480 19,271,796 24,308,175 24,378,762 26,085,275 27,911,244 29,865,031 31,955,584 34,192,475 36,585,948 39,146,964 41,887,252 44,819,359 85

Common Size Balance Sheet Actual Financial Statements 2002 2003 2004 2005 2006 AVG 05-06 AVG ASSETS CURRENT ASSETS: Cash and cash equivalents 0.55% 0.27% 0.72% 1.19% 0.58% 0.66% 0.88% Receivables, net of allowance 5.58% 5.15% 6.06% 7.50% 6.79% 6.22% 7.15% Inventories 1.15% 1.01% 1.01% 1.09% 1.32% 1.12% 1.20% Drilling advances 0.48% 0.47% 0.53% 0.76% 0.32% 0.51% 0.54% Prepaid assets and other 0.35% 0.34% 0.37% 0.69% 0.57% 0.47% 0.63% 0.00% 0.00% 0.00% 0.00% 0.65% 0.13% 0.33% Total Current Assets 8.11% 7.24% 8.70% 11.22% 10.24% 9.10% 10.73% PROPERTY AND EQUIPMENT: Total PP&E 89.49% 90.69% 89.41% 87.13% 87.82% 88.91% 87.47% OTHER ASSETS: Goodwill, net 2.00% 1.52% 1.22% 0.98% 0.78% 1.30% 0.88% Deferred charges and other 0.40% 0.55% 0.67% 0.67% 1.16% 0.69% 0.92% Total Non-Current Assets 2.40% 2.07% 1.89% 1.65% 1.94% Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Working Capital LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable... 4.72% 5.11% 7.43% 8.18% 5.80% 6.25% 6.99% Accrued operating expense... 1.04% 1.23% 1.11% 0.76% 0.63% 0.96% 0.70% Accrued exploration and development... 3.24% 3.60% 4.67% 5.27% 4.81% 4.32% 5.04% Accrued compensation and benefits... 0.72% 0.96% 1.15% 1.43% 1.15% 1.08% 1.29% Accrued interest... 0.68% 0.55% 0.45% 0.37% 0.28% 0.47% 0.33% Accrued income taxes... 0.98% 0.32% 1.07% 1.38% 0.02% 0.75% 0.70% Oil and gas derivative instruments... 0.00% 1.08% 0.29% 0.00% 0.00% 0.27% 0.00% Current Debt 0.00% 0.00% 0.00% 0.00% 16.21% 3.24% 8.11% Asset retirement obligation 0.00% 0.00% 0.00% 1.07% 3.39% 0.89% 2.23% Derivative instruments 0.00% 0.00% 0.00% 2.93% 0.63% 0.71% 1.78% Other... 0.35% 1.09% 1.42% 3.64% 1.36% 1.57% 2.50% Total Current Liabilities 11.73% 13.94% 17.58% 25.04% 34.29% 20.52% 29.67% LONG-TERM DEBT...(notes)... 47.60% 39.55% 35.47% 25.11% 18.17% 33.18% 21.64% DEFERRED CREDITS AND OTHER NONCURRENT LIABILITIES: Total Long Term Liabilities 31.04% 46.50% 46.95% 49.85% 47.55% 44.38% 48.70% PREFERRED INTERESTS OF SUBSIDIARIES... 9.63% 0.00% 0.00% 0.00% 0.00% 1.93% 0.00% Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% COMMITMENTS AND CONTINGENCIES (Note 11) SHAREHOLDERS' EQUITY: Preferred stock, no par value, 5,000,000 shares authorized -- Series B, 5.68% Cumulative Preferred Stock, 100,000 shares issued and outstanding... 2.00% 1.51% 1.20% 0.93% 0.75% 1.28% 0.84% Common stock, $0.625 par, 430,000,000 shares authorized, 332,509,478 and 310,929,080 shares issued, respectively... 3.95% 3.18% 2.55% 2.00% 1.61% 2.66% 1.80% Paid-in capital... 69.60% 61.81% 50.05% 39.57% 32.37% 50.68% 35.97% Retained earnings... 28.99% 37.44% 48.97% 61.82% 67.46% 48.94% 64.64% Treasury stock, at cost, 8,012,302 and 8,422,656 shares, respectively... -2.25% -1.61% -1.19% -0.85% -1.95% -1.57% -1.40% Accumulated other comprehensive loss... -2.29% -2.33% -1.58% -3.47% -0.24% -1.98% -1.85% Total Shareholders Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 86

Statement of Cash Flows The statement of cash flow forecasting process was started by creating a common size statement of cash flows. From here, we were able to spot any patterns and identify consistency within the statement. We computed the manipulation diagnostic ratios which consisted of: CCFO/NI, CFFO/OI, and CFFO/Sales. After examining these ratios, we found the most consistency in CFFO/Sales. We then used this to aid in our forecasting of net cash provided by operating activities, and net income. Cash flows from investing activities was forecasted out by the percentage of change in property, plant and equipment, PP&E. This is a more accurate forecast because the balance sheet generalized total assets and PP&E was more specific. Free cash flows was then determined by comparing cash flows from operations and cash flows from investing activities. Free cash flows to the firm were forecasted out negative out until 2011, and then went positive. This signals the mass acquisitions are now paying off, and the company is benefiting financially. After forecasting these cash flows out, we noticed a trend which proves reliability and legitimacy. 87

APACHE STATEMENT OF CASH FLOWS Actual Financial Statements Forecast Financial Statements 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income 554,329 1,121,885 1,668,754 2,623,730 2,552,451 2,807,696 3,088,466 3,397,312 3,737,044 4,110,748 4,521,823 4,974,005 5,471,405 6,018,546 6,620,401 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 843,879 1,073,286 1,222,152 1,415,682 1,816,359 Provision for deferred income taxes 137,672.00 546,357 444,906 598,927 751,457 Asset retirement obligation accretion - 37,763 46,060 53,720 88,931 Amortization of deferred loan costs 1,859 2,163 2,471 3,748 (173,545) International impairments 19,600 12,813 - - Cumulative effect of change in accounting principle, net of income tax - (26,632) 1,317 - Other 9,531 32,923 39,694 48,526 32,380 Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables (122,830) (94,295) (296,383) (504,038) (153,616) (Increase) decrease in inventories 717 (4,216) (659) 11,295 10,238 (Increase) decrease in drilling advances and other (26,116) (19,881) (35,761) (144,154) 66,323 (Increase) decrease in deferred charges and other 496 (29,520) (35,328) (26,454) (126,869) Increase (decrease) in accounts payable 32,219 68,176 182,454 97,447 (136,663) Increase (decrease) in accrued expenses -16595 11,227 28,431 214,491 (475,021) Increase (decrease) in advances from gas (14,574) (25,601) purchasers (16,246) (18,331) (22,108) Increase (decrease) in deferred credits and noncurrent liabilities (39,469) (9,903) (18,258) (38,542) 86,082 NET CASH PROVIDED BY OPERATING ACTIVITIES 1,380,718 2,705,900 3,231,519 4,332,270 4,312,906 4,724,604 5,055,326 5,409,199 5,787,843 6,192,992 6,626,502 7,090,357 7,586,682 8,117,749 8,685,992 CFFO/Sales 0.5394 0.6458 0.6060 0.5712 0.5203 CFFO/Operating Income 19.3608 3.1551 2.2427 1.5525 1.9665 CFFO/Net Income 2.4908 2.4119 1.9365 1.6512 1.6897 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (1,616,936) (2,456,488) (3,715,856) (3,891,639) Acquisition of ExxonMobil properties - - (348,173) - Acquisition of Anadarko properties - - (531,963) - Acquisition of BP properties (1,140,156) - - (833,820) Acquisition of Shell properties (203,033) - - Acquistion of Pioneers Argentine Operations (704,809) Acqustition of Amerada Hess Properties (229,134) Acquistion of Pan American Properties (396,056) Proceeds from China Divestiture 264,081 Proceeds from sales of oil and gas properties 7,043 58,944 4,042 79,663 4,740 Proceeds from Egypt 409,203 Additions to gas gathering, transmition, and processing facilities (248,589) Other (37,520) (57,576) (78,431) (95,649) (149,559) NET CASH USED IN INVESTING ACTIVITIES (1,236,007) (2,958,757) (3,411,013) (3,731,842) (5,775,582) (5,891,094) (6,008,916) (6,129,094) (6,251,676) (6,376,709) (6,504,243) (6,634,328) (6,767,015) (6,902,355) (7,040,402) CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings 1,467,929 1,780,870 544,824 153,368 1,779,963 Payments on long-term debt (1,553,471) (1,613,362) (283,400) (549,530) (150,266) Dividends paid (68,879) (72,832) (90,369) (117,395) (154,143) Common stock activity 30,708 583,837 21,595 18,864 31,963 Treasury stock activity, net 1,991 4,378 12,472 6,620 (166,907) Cost of debt and equity transactions (6,728) (5,417) (2,303) (861) (2,061) Repurchase of preferred interests of subsidiaries - (443,000) - - Other - 54,265 6,273 35,791 Free Cash Flows to Firm 144,711 (252,857) (179,494) 600,428 (1,462,676) (1,166,490) (953,589) (719,895) (463,833) (183,717) 122,258 456,028 819,667 1,215,394 1,645,590 NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (128,450) 234,474 257,084 (482,661) 1,374,340 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 16,261 (18,383) 77,590 117,767 (88,336) CASH AND CASH EQUIVALENTS AT BEGINNING OF Y $ 35,625 51,886 33,503 111,093 228,860 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 51,886 $ 33,503 $ 111,093 $ 228,860 $ 140,524 88

COMMON SIZE STATEMENT OF CASH FLOWS Actual Financial Statements 2002 2003 2004 2005 2006 AVG 05-06 AVG CASH FLOWS FROM OPERATING ACTIVITIES: Net income 40.15% 41.46% 51.64% 60.56% 59.18% 50.60% 59.87% Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 61.12% 39.66% 37.82% 32.68% 42.11% 42.68% 37.40% Provision for deferred income taxes 9.97% 20.19% 13.77% 13.82% 17.42% 15.04% 15.62% Asset retirement obligation accretion 0.00% 1.40% 1.43% 1.24% 2.06% 1.22% 1.65% Amortization of deferred loan costs 0.13% 0.08% 0.08% 0.09% -4.02% -0.73% -1.97% International impairments 1.42% 0.47% 0.00% 0.00% 0.00% 0.38% 0.00% Cumulative effect of change in accounting principle, net of income tax 0.00% -0.98% 0.04% 0.00% 0.00% -0.19% 0.00% Other 0.69% 1.22% 1.23% 1.12% 0.75% 1.00% 0.94% Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables -8.90% -3.48% -9.17% -11.63% -3.56% -7.35% -7.60% (Increase) decrease in inventories 0.05% -0.16% -0.02% 0.26% 0.24% 0.07% 0.25% (Increase) decrease in drilling advances and other -1.89% -0.73% -1.11% -3.33% 1.54% -1.10% -0.89% (Increase) decrease in deferred charges and other 0.04% -1.09% -1.09% -0.61% -2.94% -1.14% -1.78% Increase (decrease) in accounts payable 2.33% 2.52% 5.65% 2.25% -3.17% 1.92% -0.46% Increase (decrease) in accrued expenses -1.20% 0.41% 0.88% 4.95% -11.01% -1.19% -3.03% Increase (decrease) in advances from gas -1.06% 0.00% 0.00% 0.00% -0.59% -0.33% -0.30% purchasers 0.00% -0.60% -0.57% -0.51% 0.00% -0.34% -0.26% Increase (decrease) in deferred credits and noncurrent liabilities -2.86% -0.37% -0.56% -0.89% 2.00% -0.54% 0.55% NET CASH PROVIDED BY OPERATING ACTIVITIES 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 89

Conclusion After forecasting, we determined that the profitability of Apache realigned itself with the industry average. The hurricane in 2005 and the large acquisition in 2004, threw off their consistency in assets. Overtime, our forecasts have determined that it will eventually catch up to that of the industry. Apache is maintaining consistent growth throughout the years, making the company overall more profitable for the next 10 years. Analysis of Valuations Valuations are essential when determining the stock price of a company. The accuracy of the stock price depends on the valuation method used. Some valuations are based on industry averages, while others are based on forecasted figures. The method of comparables uses the industry average of firm s competitors in order to value the stock price. Intrinsic valuations use forecasting and assumptions to determine the stock price per share. Overall, the intrinsic valuation is the most reliable because it examines many different angles of the company. Method of Comparables Price Trailing Price / Equity $82.20 Forwarding Price / Equity $93.41 Price / Book $103.29 Dividend / Yield $72.92 Price Earnings Growth $59.88 Price / EBITDA $75.65 Enterprise Value / EBITDA $97.24 Price/Free Cash Flows N/A 90

The method of comparables is a technique that measures the price per share of a company s stock. Under this method, we computed the ratios in the summary table and then found the industry averages of Apache s competitors. Apache s competitors consist of Occidental, Anadarko, Devon, and XTO. The industry averages are then used in several calculations to determine Apache s price per share of stock. After this, evaluating Apache s stock as overvalued, undervalued or fairly valued is obvious. The outcome of our method of comparables calculations are discussed below. TRAILING PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE Apache 99.18 7.51 10.68 10.95 82.20 Occidental 66.76 4.8 12.02 Anadarko 57.24 10.39 4.84 Devon 91.31 6.41 13.08 XTO 65.68 5.01 13.84 Trailing Price to Earnings To find the trailing Price to Earnings we first had to compute Earnings per Share and Price to Earnings for Apache and its competitors. To compute these ratios we used the stock prices, number of shares outstanding, and net income from each of the company s most recent 10K. After computing each company s price to earnings ratio we took an average of our competitor s ratios by adding the four ratios together and 91

then dividing this number by four. To find the value of Apaches stock based on the trailing price to earnings model we multiplied the average Price to Earnings ratio of our competitors by Apaches Earnings per Share. This gave us a value price of $82.20 per share of Apaches stock. This model implies that Apaches current stock price per share of $99.18 is overvalued as of November 1, 2007. Apaches Price to Earnings ratio of 10.68 is also close to the average Price to Earnings of our competitors of 10.95, but if Anadarko s outlier were taken out the average would be higher. This would imply that investors are expecting Apaches earnings growth to be lower than the rest of the industry. FORWARD PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE Apache 99.18 6.67 14.15 14.01 93.41 Occidental 66.76 5.77 12.32 Anadarko 57.24 12.124 18.28 Devon 91.31 6.356 11.25 XTO 65.68 4.382 14.17 Forwarding Price to Earnings In order to calculate the Forwarding Price to Earnings ratio we needed to find each company s Earnings per Share as well as their Price to Earnings ratio. All of this information was found on Yahoo Finance. Apache s November 1, 2007 price per share 92

along with all competitors was also found on Yahoo Finance. To find the Price to Earnings ratio we simply divided the Price per Share by Earnings per Share. After finding the Price to Equity ratios for each company, we were able to compute the industry average. The industry average consisted of adding all of Apache s competitors Price to Earnings ratio and dividing the sum by four. After this, we computed Apache s price per share by multiplying the industry average by Apache s Earnings per Share. This resulted in a stock price of $93.41, when compared to Apache s stock price on November 1, 2007 of $99.18; one can see the two are very close. By way of the Forwarding Price to Earnings model, we are able to conclude that Apache s stock is fairly valued. PRICE TO BOOK PPS BPS P/B INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 43.81 2.26 2.36 103.29 Occidental 66.76 26.43 2.53 Anadarko 57.24 34.56 1.66 Devon 91.31 46.84 1.95 XTO 65.68 19.91 3.30 93

Price to Book The price to book ratio, is used to measure a stocks market value to its book value. The stock price per share was located using the price as of November 1, 2007. We found these values for our company as well as our competitors using Yahoo Finance. In order to find the Price to Book value we divided the price per share by the book value per share. This gave us the price to book value. After this, we took the industry average, which included the average of our four competitors and did not include Apache s price to book ratio. Finally, we multiplied the industry average by Apache s Book value per share. This computation gave us a result of $82.20 for the price per share of Apache s stock. According to the current stock price of Apache, $103.29, this indicates that it is fairly valued. This was no surprise because of the close proximity of Apache s price to book ratio compared to the industry price to book ratio. DIVIDEND YIELD PPS DPS D/P INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 0.15 0.0015 0.0021 72.92 Occidental 66.76 0.22 0.0033 Anadarko 57.24 0.09 0.0016 Devon 91.31 0.14 0.0015 XTO 65.68 0.12 0.0018 94

Dividend Yield Using the dividend yield, informs investors and managers the amount of dividends the company pays out based on its stock price per share. The dividends were found using Yahoo Finance, and then the ratio Dividend to Price was found. Once this was done, we were able to compute the industry average. The industry average consisted adding the Dividend to Price ratio of all of Apache s competitors, and then dividing by four. Apache s stock price was computed by dividing their dividend per share, as of November 1, 2007, by the industry average. The price per share ended up being $72.92, which makes the current stock price overvalued when comparing it with its current stock price of $99.18. Price Earnings Growth Price Earnings Growth, or PEG, is a measure of a stocks overall value while considering earnings growth. Using Yahoo Finance, we were able to find the PEG for all of Apache s competitors. By adding each company, with the exception of Apache, and dividing by all four of the competitors we were able to determine the industry average. From here, we were able to conclude Apache s stock price per share by multiplying the industry average by Apache s total revenue growth rate of 7%, and then multiplying that value by Apache s EPS. The stock price per share of Apache based on this model is $59.88. Clearly, this price is much lower than the November 1, 2007 stock price of $99.18. We can conclude the current price of Apache s stock is overvalued. PRICE EARNINGS GROWTH PPS EPS PEG INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 6.67 1.78 1.28 59.88 Occidental 66.76 5.77 1.18 Anadarko 57.24 12.124 1.95 Devon 91.31 6.356 1.27 XTO 65.68 4.382 0.73 95

PRICE TO EBITDA PPS EBITDA (IN BILLIONS) P/EBITDA INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 6.77 14.65 11.17 75.65 Occidental 66.76 9.38 7.12 Anadarko 57.24 6.74 8.49 Devon 91.31 7.51 12.16 XTO 65.68 3.88 16.93 Price to EBITDA Price to EBITDA takes into consideration the price per share compared to Earnings before interest, taxes, depreciation, and amortization. We found Apache s EBITDA on the December 31, 2006 10-K and recorded it on the graph above as a decimal of a billion. From here we were able to compute the Price to EBITDA ratio by dividing the price per share by their EBITDA. After this, we were able to find the industry average by adding Apache s competitors Price to EBITDA ratio, taking that sum and dividing it by four. This gave us an industry average of 11.17 which we used in calculating the price per share of Apache s stock. Along with the Industry average, we used Apache s EBITDA and multiplied the two. The product of this gave us our price per share of $75.65. This too makes Apache s stock overvalued. 96

ENTERPRISE VALUE TO EBITDA EV EBITDA (IN BILLIONS) EV/EBITDA INDUSTRY AVERAGE APA SHARE PRICE Apache 43.78 6.77 6.47 6.37 97.24 Occidental 58.26 9.38 6.21 Anadarko 39.89 6.74 5.92 Devon 43.06 7.51 5.73 XTO 29.52 3.88 7.61 Enterprise Value to EBITDA Enterprise value to EBITDA, earnings before interest, taxes, depreciation, and amortization, takes into account companies Enterprise Value based on its EBITDA. We found Apache s competitors Enterprise Value as well as EBITDA on Yahoo Finance. For Apache, we located their EBITDA on the December 31, 2006 10-K. The Enterprise Value was computed by adding Apache s price per share with the book value of liabilities, and subtracting cash and cash equivalents. This resulted in Apache s Enterprise Value being 43.78. Next, we divided Enterprise Value by EBITDA in order to find Enterprise Value to EBITDA. After this, we calculated the industry average by adding Apache s competitors Enterprise Value to EBITDA ratios and dividing it by four. The stock price consisted of first multiplying the industry average by Apache s EBITDA which resulted in $43.1 billion. Then, we subtracted Apache s book value of liabilities, $11.0, and added cash and cash equivalents, $0.140 billion. We ended up with $34.16, and then divided this number by the number of shares Apache has outstanding, 0.330737 billion. After these calculations were complete, the formula gave us a stock 97

price of $97.24. Obviously, this is extremely close to the actual November 1, 2007 stock price of Apache. According to this model, our stock price is fairly valued. This was not surprising, because our Enterprise Value to EBITDA ratio is particularly close to the industry average. Price to Free Cash Flows The Price to Free Cash Flows ratio compares a company s market value, or price, to its free cash flows. To compute this, we added Apache s Operating Cash Flows, $4.31 billon, with its Investing Cash Flows, $(5.78) billion. We ended up with a free cash flow total of $(1.46) billion. Due to the negative cash flow, we decided to throw this model out because of its lack of value. If we were to continue to compute the Price to Free Cash Flow ratio, we would gather our competitors Operating Cash Flows and Investing Cash Flows. After adding the two, we would divide the company s November 1, 2007 stock price by the free cash flow. Then we would determine the price per share of the stock. However, due to the negative free cash flow of Apache, this model will not be a valid indicator of our stock price per share. Conclusion According to most of the method of comparable computations, Apache is an overvalued company. Only two models, Forwarding Price to Equity and Enterprise Value to EBITDA, gave us a result which reported that Apache was fairly valued. Using the method of comparables to attempt to find the price per share of stock is not the most reliable method. Also, the method of comparables does not take into account that you may operate or be different from your competitors. This is evident when computing the industry average based solely on your competitors figures. The Intrinsic Valuation is a much more reliable and sensible Cost of Equity The cost of equity, ke, is determined by using the CAPM model. The cost of equity is an estimation of the firm s expected return on stock or securities for the 98

current year. In order to compute the cost of equity using the CAPM model, we had to gather the risk-free rate, the expected market return, and also Apache s beta. We found Apache s beta from a regression analysis. The beta with the highest r-squared was used because it is correct the most amount of time. The risk-free rate was obtained from the St. Louis Federal Reserve website, where Treasury bill rates are listed. The market risk premium was calculated by subtracting the risk-free rate from the S&P 500 rate of returns. We used regression data analysis to compute the beta and r-squared for 72, 60, 48, 36, and 24 month periods. These time intervals are important because they assess the overall stability of beta. Using a large range of intervals cuts out any outliers and inconsistencies. We ran a regression for all of these periods using the 3 month, 6 month, 2 year, 5 year, 7 year, and 10 year Treasury bill rates. The beta in the 3 month, 6 month, 2 year, and 5 year ranges was extremely consistent, at an almost constant 1.60. The beta in years 7 and 10 was also constituent holding at a.14. The highest r-squared was in the 24 month period in every regression we computed. Using the CAPM model, we were able to determine that the cost of equity, ke, to be 15.73%. 99

Regression Analysis 3 MO Rate 72 60 48 36 24 RF 3.99 3.99 3.99 3.99 3.99 R2-0.01-0.02 0.00 0.15 0.19 Beta -0.31-0.33 1.31 1.42 1.60 ke 3.99 3.99 4.00 4.00 4.01 6 MO Rate 72 60 48 36 24 RF 4.20 4.20 4.20 4.20 4.20 R2-0.01-0.02 0.00 0.15 0.19 Beta -0.31-0.33 1.31 1.42 1.60 ke 4.20 4.20 4.21 4.21 4.22 2 YR Rate 72 60 48 36 24 RF 4.01 4.01 4.01 4.01 4.01 R2-0.01-0.01 0.00 0.15 0.19 Beta -0.31-0.34 1.29 1.41 1.60 ke 4.01 4.01 4.02 4.02 4.03 5 YR Rate 72 60 48 36 24 RF 4.20 4.20 4.20 4.20 4.20 R2-0.01-0.01 0.00 0.14 0.19 Beta -0.32-0.35 1.25 1.41 1.59 ke 4.20 4.20 4.21 4.21 4.22 7 YR Rate 72 60 48 36 24 RF 4.33 4.33 4.33 4.33 4.33 R2-0.01-0.01 0.00 0.14 0.19 Beta -0.01-0.01 0.02 0.12 0.14 Ke 4.33 4.33 4.33 4.33 4.33 10 YR Rate 72 60 48 36 24 100

RF 4.52 4.52 4.52 4.52 4.52 R2-0.01-0.01 0.00 0.14 0.19 Beta -0.01-0.01 0.02 0.12 0.14 ke 4.52 4.52 4.52 4.52 4.52 Cost of Debt To find the cost of debt for Apache Corp. we had to find an interest rate for all current and long term debt. To find the rate for long term debt we were able to take a weighted average of the rates for their outstanding bonds, debentures, lines of credit and commercial paper. Apache did a good job of disclosing their long term debt in their annual report and provided rates for each item along with their maturities. For long term debt we came up with a weighted average rate of 5.83%. For Apaches current liabilities, such as their accounts payable, we used the one month AA financial commercial paper rate of 4.76%. We also needed to find a rate for Apaches deferred income taxes since it is a main contributor to their overall debt. For this rate we chose to use the one year government risk free rate of 4.10%. After applying each rate to the designated debt we took a weighted average of the total debt and came up with a cost of debt of 4.74%. Weighted Average Cost of Capital To find the weighted average cost of capital (WACC) we used the following formula: E/V * Re + D/V * Rd * (1-Tc). Where Re is the cost of equity and Rd is the cost of debt both of which were calculated earlier. E is the value of the firm s equity and D is the value of the firm s debt. V is computed by adding E and D together. After plugging Apache s computed numbers into the WACC formula we found their before tax weighted average cost of capital to be 4.34%. Using a 35% corporate income tax rate we computed the after tax weighted cost of capital to be 3.59%. 101

Intrinsic Valuations The intrinsic valuation methods used to value Apache Oil Corporation were the discount dividend model, the free cash flows model, the residual income model, and the long run residual income model. These models are superior to the method of comparables models because they examine many different angles of the company. Using these models, it is easier to get an overall view of Apache Oil. Discount Dividends Model Shareholders receive value of a firm through dividends. The discount dividends model shows the value of the future dividends, which is also how shareholders determine the amount of value they will receive from the firm. The model forecasts out future dividends and discounts them back to the present. If the value given by the discount dividends model is higher than the current stock price, then the company s stock is undervalued. The discount dividends model is only as reliable as the assumptions used. The model requires assumed discount prices, as well as growth rates. In reality, it is not likely that a company s dividends will grow at a constant growth rate indefinitely. For this reason, this model cannot be extremely dependable. Sensitivity Analysis Growth 0 0.02 0.04 0.06 0.08 0.09 0.1 $11.06 $12.45 $14.76 $19.39 $33.27 $61.02 0.12 $8.99 $9.78 $10.95 $12.92 $16.84 $20.76 ke 0.14 $7.55 $ 8.02 $8.69 $9.69 $11.36 $12.69 0.157 $6.62 $6.95 $7.39 $8.00 $8.94 $9.61 0.18 $5.67 $5.88 $6.14 $6.48 $6.97 $7.29 0.2 $5.04 $5.18 $5.35 $5.57 $5.87 $6.06 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 102

To begin valuing Apache Oil Corporation using the discount dividends model, the first step was to forecast out the dividend prices. There was a consistent growth rate of 25% in the dividend prices through 2002 to 2006. Although the growth rate was constant, we decided that a 25% growth rate over the next 10 years would be too large. Instead, we grew the dividend price at $.08 per year. This growth seemed to be more realistic and could provide us with the most reliable valuations. We then discounted the dividends back to the present value and found the sum of these. We then used the perpetuity equation to value the firm from beyond the forecasted out 10 years. To determine the final value of the company, we added the value of the firm for the next 10 years with the value of the perpetuity. The results from the discount dividends model show that Apache Oil is largely undervalued. This means that there is a very small amount of dividends that are being paid out to shareholders, which is not beneficial for them. The reliability of this model could have been compromised by our assumptions, but there is no way of knowing this. In order for Apache s stock to be fairly valued, the cost of equity would need to be Free Cash Flows Model To create the free cash flows model, the first step was to calculate the annual free cash flows. This was done by the cash flows from investing activates from cash flows from operating activities. We then calculated the present value factor. This was used in calculating the present value of the annual free cash flows by multiplying the present value factor by the annual free cash flow. We added all of these together to get the total present value of annual free cash flows. The continuing terminal value perpetuity was then computed by dividing year 10 s cash flow from investing activities by the initial before tax WACC minus the growth rate. This number was multiplied by year 10 s present value factor to get the present value of terminal value perpetuity. The value of the firm was then computed by adding together the total present value of total free cash flows and the the present value of terminal value perpetuity. The 103

estimated market value of equity was then computed by the book value of liabilities from the value of the firm. The estimated price per share was the calculated by dividing the estimated market value of equity by the number of shares outstanding. Finally, the time consistent implied price, which are the numbers that are included in the sensitivity analysis, are computed by multiplying the estimated price per share by one plus the initial before tax WACC and taking that forward 2 months. Sensitivity Analysis Growth 0 0.02 0.03 0.04 0.045 0.05 $ 7.64 $ (178.89) $ (412.05) $ (1,111.55) $ (2,510.53) 0.06 $ 62.23 $ (43.81) $ (149.85) $ (361.93) $ (574.00) WACC 0.07 $ 96.56 $ 30.36 $ (27.56) $ (124.09) $ (201.32) 0.0852 $ 126.84 $ 90.62 $ 62.67 $ 22.35 $ (5.33) 0.09 $ 132.91 $ 102.35 $ 79.43 $ 47.34 $ 25.95 0.1 $ 141.96 $ 119.99 $ 104.30 $ 83.38 $ 70.17 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 Our sensitivity analysis shows that Apache s stock is overvalued. This model has the most fairly valued share prices out of all the sensitivity analyses computed. This model also has the most undervalued share prices in comparison to the others. Despite this, the sensitivity analysis shows that Apache s stock price is largely overvalued. Residual Income Model The residual income model is the most reliable of the intrinsic valuation methods. This is because the overall value of the firm includes a high percentage of the present value of residual income. This number is based off of the forecasted out earnings of the firm, which is why this model is the most accurate. 104

Sensitivity Analysis Growth 0-0.05-0.1-0.15-0.2-0.25 0.1 $ 26.15 $ 29.08 $ 30.55 $ 31.43 $ 32.02 $ 32.44 0.12 $ 31.68 $ 33.18 $ 34.00 $ 34.52 $ 34.87 $ 35.13 ke 0.14 $ 35.39 $ 36.19 $ 36.66 $ 36.97 $ 37.19 $ 37.35 0.157 $ 37.72 $ 38.21 $ 38.51 $ 38.71 $ 38.86 $ 38.97 0.18 $ 40.18 $ 40.44 $ 40.61 $ 40.72 $ 40.81 $ 40.87 0.2 $ 41.91 $ 42.06 $ 42.16 $ 42.23 $ 42.29 $ 42.33 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 To derive the numbers used in the residual income model, earnings had to be forecasted out. The difference between the operating cash flows and investing cash flows are the actual earnings. We then determined the benchmark earnings, which is the previous year s earnings multiplied by the cost of equity. The residual income is the difference between the actual earnings and the benchmark earnings. Our sensitivity analysis determined that, once again, Apache s stock is highly overvalued. In order to make our stock price fairly valued, Apache would need to greatly decrease their cost of equity, or highly increase their growth rate. Both of these options are unrealistic and would be impossible for the firm to follow through with. 0 1 2 3 4 5 6 7 8 9 10 11 PV of Annual Residual Income 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 $ 343,602 $ 155,413 $ 14,061 $ (90,291) $ (165,539) $ (218,010) $ (252,765) $ (285,474) $ (282,951) $ (286,095) $ (267,970) Residual income, which is the added or destroyed value of the firm, is the main component in the residual income model. After the residual income was computed for each year, it was then brought back to the present by multiplying each year s residual income by the present value factor. This number demonstrates whether the company is adding or taking away value from the firm. 105

As a company continues to grow, their residual income will eventually decrease until it declines to or past zero. Every company s residual income will join with the market. Apache s residual income goes negative on the fourth forecasted year. It is difficult to be sure that this number is correct because of the assumptions that had to be made about forecasted earnings. Abnormal Earnings Growth Model The first step in creating the abnormal earnings growth model is to find the company s earnings and dividends. These are used in computing the Drip income, which is dividends paid multiplied by the cost of equity. We then determined cumulative earnings, which is calculated by adding the earnings of the company to the drip earnings for each year. Normal earnings are then computed by multiplying each year s earnings by the cost of equity. Abnormal earnings growth is finally determined by subtracting the normal earnings from the cumulative dividend earnings. These values were then brought back to the present by multiplying them by the present value factor. These were all added together to get the total present value of abnormal earnings, which we calculated to be 1,308,635.15. We then computed a continuing terminal value, which was the forecasted abnormal earnings growth for year 11, divided by Apache s cost of equity minus the growth rate. The continuing terminal value was then multiplied by the forecasted year 10 s present value factor to determine the present value of the terminal value. The core earnings per share, which equals year zero s earnings, was added to the present value of the AEG to determine the total average earnings per share perpetuity in time 1. We finally computed the intrinsic value per share, which is the total average earnings per share perpetuity in time one divided by the cost of equity. Finally, the numbers in our sensitivity analysis were computed by multiplying the intrinsic value per share by one plus the cost of equity and then bringing this number forward 2 months. 106

The numbers included in the sensitivity analysis were determined by changing the cost of equity and the growth rate. Growth 0-0.05-0.1-0.15-0.2-0.25 0.1 $ 22.24 $ 28.40 $ 31.48 $ 33.33 34.56 35.44 0.12 $ 21.42 $ 25.25 $ 27.34 $ 28.65 29.56 30.22 ke 0.14 $ 20.25 $ 22.81 $ 24.30 $ 25.27 25.96 26.48 0.157 $ 19.23 $ 21.12 $ 22.27 $ 23.05 23.61 24.03 0.18 $ 17.94 $ 19.25 $ 20.10 $ 20.68 21.12 21.45 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 After the numbers in the sensitivity analysis were computed, the results showed that, again, Apache s stock price is highly overvalued. The numbers were significantly below the November 1 st, 2006 stock price of $99.18. The AEG model and residual income model are linked. The change in residual income from year to year is equal to the abnormal earnings growth computed. Annual AEG Change in RI 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 $ $ $ $ $ $ $ $ $ $ (446,501) (188,528) (199,497) (211,525) (224,686) (239,060) (254,728) (321,791) (232,478) (311,459) $ $ $ $ $ $ $ $ $ (188,528) (199,497) (211,525) (224,686) (239,060) (254,728) (321,786) (232,478) (311,459) This chart shows the consistency between the annual AEG and the change in residual income per year. Because of this link, the share prices determined in the residual income model and the abnormal earnings growth model should be similar. The greatest difference in the share prices determined in both models is at most $20, and at the least, less than $1. The reason for the difference in these share prices is because the present value of the perpetuities is different in each model. The differences in the share prices will lessen as the perpetuity grows towards infinity, and because a portion 107

of the share prices are only off by less than $1, this shows that both models are closely linked. Long Run Residual Income Model The long run residual income model is also a reliable model because it links the cost of equity, long run return on equity, and the long run growth on equity. The first sensitivity analysis is determined by holding the cost of equity constant, and changing the return on equity and the growth rate on equity. The different stock prices are computed by multiplying the book value of equity by one plus the return on equity minus the cost of equity, divided by the cost of equity minus the growth. Sensitivity Analysis Ke= 15.7% Growth 0.14 0.16 0.18 0.2 0.22 0.15 $ 23.46 $ 132.95 $ 52.02 $ 46.38 $ 44.32 ROE 0.17 $ 70.38 $(132.95) $ 17.34 $ 27.83 $ 31.65 Overvalued > 114.06 0.19 $ 117.31 $(398.84) $ (17.34) $ 9.28 $ 18.99 0.21 $ 164.23 $(664.73) $ (52.02) $ (9.28) $ 6.33 0.23 $ 211.15 $(930.62) $ (86.70) $ (27.83) $ (6.33) Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 The next sensitivity analysis was determined holding the growth rate of equity constant and changing the cost of equity and the return on equity. 108

Sensitivity Analysis Growth= 17.77% Ke 0.12 0.14 0.16 0.18 0.2 0.15 $ 19.13 $ 29.29 $ 62.48 $(469.27) $ (49.34) ROE 0.17 $ 5.29 $ 8.10 $ 17.29 $(129.83) $ (13.65) 0.19 $ (8.54) $ (13.08) $ (27.91) $ 209.60 $ 22.04 0.21 $ (22.38) $ (34.27) $ (73.10) $ 549.04 $ 57.73 0.23 $ (36.22) $ (55.46) $ (118.30) $ 888.48 $ 93.42 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 The last sensitivity analysis was computed holding the return on equity constant, while changing the growth of equity and the cost of capital. Sensitivity Analysis ROE= 18.6% Growth 0.13 0.15 0.17 0.19 0.21 0.12 $(223.43) $ (47.89) $ (12.78) $ 2.27 $ 10.63 Ke 0.14 $ 223.43 $(143.66) $ (21.30) $ 3.17 $ 13.66 0.16 $ 74.48 $ 143.66 $ (63.89) $ 5.29 $ 19.13 0.18 $ 44.69 $ 47.89 $ 63.89 $ 15.87 $ 31.88 0.2 $ 31.92 $ 28.73 $ 21.30 $ (15.87) $ 95.64 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% Actual Price per Share as of 11/1/06= $99.18 To calculate the return on equity, we averaged the return on equity from the past 5 years. We then calculated the growth of equity, which we calculated by 109

averaging the growth of the book value of equity from the past 5 years also. These three sensitivity analyses also show that Apache s stock is overvalued. Credit Analysis We measured the financial health of Apache by using the Altman Z-Score model, which predicts the probability of a company failing financially. The Altman Z-Score model uses five financial ratios to compute the likelihood a company is to falling into bankruptcy. According to the model a company with a z-score of 3 or more is financially healthy and at low risk to fall into bankruptcy. A z-score between 1.8 and 3 lies in a grey area and is at a higher risk for financial failure. While a score of less than 1.8 is an indicator that a company is likely to experience financial failure. The Altman Z-Score is computed by using the following equation: 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 Equity) + 1.0 (Sales/Total Assets) By inputting Apaches financial figures in the Altman Z-Score model we computed a current score of 3.32. We also computed the Z-Score for the previous four years and found that Apache has stayed consistently within the Z-Score range of being financially healthy except for in 2004. In 2004 their score dropped to 2.72 and into the grey area. We attribute this decline in the rating to the fact that their market value of equity declined substantially and their book value of liabilities continued to grow. Even though the score did decline in 2004 it was still in the upper range of the grey area and did increase in 2005 back to a level above the 3.0 threshold. 110

Altman Z-Score 2002 2003 2004 2005 2006 Z-Score 3.51 3.97 2.72 3.13 3.32 Analyst Recommendation After reviewing Apache s financial statements, industry analysis, accounting analysis, valuations, and forecasted future financial statements, we were able to determine that Apache s stock price is overvalued. Our recommendation for Apache s current stockholders would be to sell. Apache s financial statements were forecasted using industry averages, as well as their past and current financial statements. This industry average was taken from the 10-K s and financial statements of their four main competitors, Anadarko, Devon Energy, XTO Energy, and Occidental. Apache s ratios were consistent with the industry average which helps make our forecasting credible. Apache uses high levels of disclosure and apart from using the aggressive full cost method, uses relatively conservative accounting practices. This is also in line with the industry norm as the oil and gas industry as a whole has a relatively high level of disclosure. Apache s accounting ratios did not reflect any unusual accounting practices that would have led to an overstatement of net income, to make the company more attractive to investors. In order to properly value Apache, we used two different types of commonly used valuation methods. The first one is the method of comparables and the second is the intrinsic valuation methods. Overall the intrinsic valuation method is more reliable than the method of comparables because it examines many more angles of the 111

company. The method of comparables valuation method stated that Apache was only slightly overvalued whereas the more reliable intrinsic valuation method stated that Apache was highly overvalued. On September 6, 2007, when we began valuing Apache, its stock price closed at $80.40. As we finish our analysis on December 5, 2007, the stock price has closed at $98.38. We used Apache s closing stock price from November 1, 2007, which was $99.18 in all of our valuations. Though Apache s stock prices rose consistently from September 6 to November 1, these numbers are somewhat misleading as this can for the most part be contributed to the rising oil prices. Each one of Apache s four competitors had similar growth in stock price which lends credibility to the reason why despite rising stock prices, Apache is still highly overvalued. As oil prices steady and taper off, their stock prices will as well, which is why we are recommending that any investor holding Apache s stock sell it as soon as possible. 112

Appendix Liquidity Ratios Current Ratio 2002 2003 2004 2005 2006 APA 1.44 1.09 1.05.99.65 APC.69.77 1.26 1.21.28 DVN 1.02 1.14 1.16 1.43.69 OXY.84.98 1.29 1.54 1.27 XTO.86.81.87 1.07 1.28 Inventory Turnover 2002 2003 2004 2005 2006 APA 5.5 8.3 7.05 7.61 6.4 APC N/A N/A N/A N/A N/A DVN 90.19 36.25 N/A N/A N/A OXY 6.89 7.82 8.27 7.53 7.61 XTO N/A N/A N/A N/A N/A Quick Asset Ratio 2002 2003 2004 2005 2006 APA 1.15.87.86.82.47 APC.61.68 1.16.90.23 DVN.94 1.07 1.11 1.31.58 OXY.55.73 1.07 1.29 1.03 XTO.70.66.71.95 1.18 Accounts Receivable Turnover Days Supply of Inventory 2002 2003 2004 2005 2006 APA 66.36 43.97 51.77 47.96 57.03 APC N/A N/A N/A N/A N/A DVN 4.05 10.07 N/A N/A N/A OXY 52.98 46.68 44.14 47.96 57.03 XTO N/A N/A N/A N/A N/A 2002 2003 2004 2005 2006 APA 4.85 6.56 5.67 5.25 5.02 APC 3.48 4.64 4.49 3.70 3.10 DVN 6.21 7.68 6.96 6.71 7.59 OXY 6.80 8.08 5.09 4.84 5.46 XTO 5.57 6.00 5.69 5.18 6.34 Days Sales Outstanding 2002 2003 2004 2005 2006 Working Capital Turnover 2002 2003 2004 2005 2006 APA 10.91 53.25 80.93-309.73-6.27 APC -6.64-13.10 11.92 13.84-0.84 DVN 196.18 25.09 19.02 8.44-7.38 OXY -20.27-179.35 11.28 6.63 14.17 XTO -19.71-20.03-30.43 59.64 13.26 APA 75.26 55.64 64.37 69.52 72.71 APC 104.77 78.67 81.22 98.65 117.92 DVN 58.78 47.51 52.43 54.41 48.07 OXY 53.67 45.17 71.76 75.39 66.81 XTO 65.50 60.81 64.13 70.43 57.59 113

Profitability Ratios Gross Profit Margin 2002 2003 2004 2005 2006 APA.351.459.499.555.484 APC.741.761.846.881.777 DVN.457.645.828.811.687 OXY.539.572.603.636.654 XTO.841.753.874.885.893 Return on Assets 2002 2003 2004 2005 2006 APA.062.119.134.169.132 APC.049.068.078.122.215 DVN.008.108.080.098.094 OXY.005.092.141.247.160 XTO.164.189.255 N/A.189 Operating Profit Margin 2002 2003 2004 2005 2006 APA.358.461.530.577.508 APC.369.431.475.565.479 DVN.125.359.403.455.419 OXY.290.340.381.423.447 XTO.431.422.472.558.584 Return on Equity 2002 2003 2004 2005 2006 APA.125.228.255.320.242 APC.130.178.186.266.439 DVN.022.375.198.214.191 OXY.176.242.324.501.278 XTO.425.553.627 N/A.442 Net Profit Margin 2002 2003 2004 2005 2006 APA.216.268.313.346.308 APC.215.243.264.347.476 DVN.024.238.238.273.269 OXY.135.164.226.347.230 XTO.230.242.261.327.406 Asset Turnover 2002 2003 2004 2005 2006 APA.271.337.344.394.341 APC.212.249.300.314.173 DVN.266.271.309.355.302 OXY.443.513.531.582.561 XTO.306.329.319.357.355 114

Capital Structure Ratios Times Interest Earned Debt to Equity Ratio 2002 2003 2004 2005 2006 APA.921.901.890.828.843 APC.609.602.565.505 1.050 DVN 2.487 1.457 1.196 1.037 1.010 OXY 1.691 1.291 1.028.737.687 2002 2003 2004 2005 2006 APA 10.57 13.36 15.88 19.26 19.68 APC 1.05 7.02 8.69 8.22 19.98 DVN -1.02 10.17 12.41 11.61 9.74 OXY.687 4.00 4.82 10.02 26.23 XTO 1.197 1.16.90 1.00 N/A XTO 1.917 1.464 1.351 1.342 1.197 Debt Service Margin 2002 2003 2004 2005 2006 APA 1.2.90 1.2 1.35.143 APC 1.3 1.14.98.89.140 DVN 2.34 2.12 1.89 1.34 1.39 OXY 2.45 1.23 1.21.87.142 XTO 2.56 1.25 2.68 2.63 2.64 115

Method of Comparables TRAILING PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE Apache 99.18 7.51 10.68 10.95 82.20 Occidental 66.76 4.8 12.02 Anadarko 57.24 10.39 4.84 Devon 91.31 6.41 13.08 XTO 65.68 5.01 13.84 FORWARD PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE Apache 99.18 6.67 14.15 14.01 93.41 Occidental 66.76 5.77 12.32 Anadarko 57.24 12.124 18.28 Devon 91.31 6.356 11.25 XTO 65.68 4.382 14.17 PRICE TO BOOK PPS BPS P/B INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 43.81 2.26 2.36 103.29 Occidental 66.76 26.43 2.53 Anadarko 57.24 34.56 1.66 Devon 91.31 46.84 1.95 XTO 65.68 19.91 3.30 DIVIDEND YIELD PPS DPS D/P INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 0.15 0.0015 0.0021 72.92 Occidental 66.76 0.22 0.0033 Anadarko 57.24 0.09 0.0016 Devon 91.31 0.14 0.0015 XTO 65.68 0.12 0.0018 116

PRICE EARNINGS GROWTH PPS EPS PEG INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 6.67 1.78 1.28 59.88 Occidental 66.76 5.77 1.18 Anadarko 57.24 12.124 1.95 Devon 91.31 6.356 1.27 XTO 65.68 4.382 0.73 PRICE TO EBITDA PPS EBITDA (IN BILLIONS) P/EBITDA INDUSTRY AVERAGE APA SHARE PRICE Apache 99.18 6.77 14.65 11.17 75.65 Occidental 66.76 9.38 7.12 Anadarko 57.24 6.74 8.49 Devon 91.31 7.51 12.16 XTO 65.68 3.88 16.93 ENTERPRISE VALUE TO EBITDA EV EBITDA (IN BILLIONS) EV/EBITDA INDUSTRY AVERAGE APA SHARE PRICE Apache 43.78 6.77 6.47 6.37 97.24 Occidental 58.26 9.38 6.21 Anadarko 39.89 6.74 5.92 Devon 43.06 7.51 5.73 XTO 29.52 3.88 7.61 Price Trailing Price to Equity 82.20 Forwarding Price to Equity 93.41 Price to Book 103.29 Dividend Yield 72.92 Price Earnings Growth 59.88 Price To EBITDA 75.65 Enterprise Value to EBITDA 97.24 Price to Free Cash Flows N/A 117

3 Month SUMMARY OUTPUT 72 Regression Statistics Beta R2-adj Multiple R 0.062036002 72-0.31-0.010 R Square 0.003848466 60-0.33-0.015 Adjusted R Square -0.010382271 48 1.31-0.00054 Standard Error 0.175962341 36 1.42 0.1471 Observations 72 24 1.60 0.1882 ANOVA df SS MS F Significance F Regression 1 0.008373359 0.008373359 0.270433341 0.604682012 Residual 70 2.16739218 0.030962745 Total 71 2.175765538 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.024669263 0.020851013 1.183120586 0.240764038-0.016916771 0.066255298-0.016916771 0.066255298 X Variable 1-0.312349764 0.600635594-0.520032057 0.604682012-1.510279669 0.885580141-1.510279669 0.885580141 SUMMARY OUTPUT 60 Regression Statistics Multiple R 0.046194937 R Square 0.002133972 Adjusted R Square -0.015070614 Standard Error 0.190440944 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.004498473 0.004498473 0.124035076 0.725975163 Residual 58 2.103529678 0.036267753 Total 59 2.108028151 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.028490886 0.025529127 1.116014882 0.269018171-0.022611214 0.079592986-0.022611214 0.079592986 X Variable 1-0.333295185 0.946360885-0.352186138 0.725975163-2.227642299 1.561051929-2.227642299 1.561051929 SUMMARY OUTPUT 48 Regression Statistics Multiple R 0.144049122 R Square 0.02075015 Adjusted R Square -0.000537891 Standard Error 0.194068708 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.036711031 0.036711031 0.974732734 0.328667527 Residual 46 1.732482525 0.037662664 Total 47 1.769193556 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.028507299 0.028957966 0.984437195 0.330050394-0.029782063 0.086796661-0.029782063 0.086796661 X Variable 1 1.307185203 1.324019397 0.987285538 0.328667527-1.357927572 3.972297979-1.357927572 3.972297979 SUMMARY OUTPUT 36 Regression Statistics Multiple R 0.414063 R Square 0.171448 Adjusted R Square 0.147079 Standard Error 0.068563 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.033073 0.033073 7.035433817 0.012055422 Residual 34 0.159832 0.004701 Total 35 0.192905 Coefficientstandard Erro t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011859 0.011815 1.003704 0.32261166-0.012151971 0.035869024-0.012151971 0.035869024 X Variable 1 1.420602 0.535583 2.652439 0.012055422 0.332165838 2.509037622 0.332165838 2.509037622 SUMMARY OUTPUT 24 Regression Statistics Multiple R 0.472759775 R Square 0.223501805 Adjusted R Square 0.188206432 Standard Error 0.062528658 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.024758338 0.024758338 6.332325997 0.019649258 Residual 22 0.086016328 0.003909833 Total 23 0.110774666 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00738025 0.013451706 0.54864789 0.588772369-0.02051688 0.03527738-0.02051688 0.03527738 X Variable 1 1.603336149 0.637151855 2.516411333 0.019649258 0.281964083 2.924708215 0.281964083 2.924708215 118

6 month SUMMARY OUTPUT 72 6 month Regression Statistics Beta R2 adj Multiple R 0.062149583 72-0.312799477-0.010367964 R Square 0.003862571 60-0.333829883-0.015060586 Adjusted R Square -0.010367964 48 1.306478277-0.000532982 Standard Error 0.175961095 36 1.417708476 0.14658208 Observations 72 24 1.60000198 0.187282275 ANOVA df SS MS F Significance F Regression 1 0.008404048 0.008404048 0.271428357 0.604019486 Residual 70 2.16736149 0.030962307 Total 71 2.175765538 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.024632189 0.020843166 1.181787337 0.241289309-0.016938193 0.066202572-0.016938193 0.066202572 X Variable 1-0.312799477 0.600396856-0.520987866 0.604019486-1.510253232 0.884654279-1.510253232 0.884654279 SUMMARY OUTPUT Regression Statistics Multiple R 0.04630152 R Square 0.002143831 Adjusted R Square -0.015060586 Standard Error 0.190440003 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.004519 0.004519 0.124609323 0.725367825 Residual 58 2.103509 0.036267 Total 59 2.108028 Coefficients tandard Erro t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0% Intercept 0.02845077 0.025494 1.11596 0.269041496-0.022581889 0.079483-0.02258 0.079483 X Variable 1-0.333829883 0.945692-0.353 0.725367825-2.226839072 1.559179-2.22684 1.559179 SUMMARY OUTPUT Regression Statistics Multiple R 0.144065798 R Square 0.020754954 Adjusted R Square -0.000532982 Standard Error 0.194068232 Observations 48 ANOVA df SS MS F ignificance F Regression 1 0.03672 0.03672 0.974963 0.328611 Residual 46 1.732474 0.037662 Total 47 1.769194 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.02871445 0.028905 0.993401 0.325712-0.02947 0.086898-0.02947 0.086898 X Variable 1 1.306478277 1.323147 0.987402 0.328611-1.35688 3.969835-1.35688 3.969835 SUMMARY OUTPUT Regression Statistics Multiple R 0.413479684 R Square 0.170965449 Adjusted R Square 0.14658208 Standard Error 0.068583395 Observations 36 ANOVA df SS MS F ignificance F Regression 1 0.03298 0.03298 7.01156 0.012189 Residual 34 0.159925 0.004704 Total 35 0.192905 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95% ower 95.0%Upper 95.0% Intercept 0.012101178 0.011796 1.025845 0.312208-0.01187 0.036074-0.01187 0.036074 X Variable 1 1.417708476 0.535402 2.647935 0.012189 0.329642 2.505775 0.329642 2.505775 SUMMARY OUTPUT Regression Statistics Multiple R 0.471823938 R Square 0.222617828 Adjusted R Square 0.187282275 Standard Error 0.06256424 Observations 24 ANOVA df SS MS F ignificance F Regression 1 0.02466 0.02466 6.300109 0.019927 Residual 22 0.086114 0.003914 Total 23 0.110775 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95% ower 95.0%Upper 95.0% Intercept 0.007609698 0.013433 0.566476 0.576804-0.02025 0.035469-0.02025 0.035469 X Variable 1 1.60000198 0.637451 2.510002 0.019927 0.27801 2.921993 0.27801 2.921993 119

2 year SUMMARY OUTPUT Regression Statistics Beta R2 adj Multiple R 0.062607738 72-0.314123352-0.01030999 R Square 0.003919729 60-0.341492122-0.01495454 Adjusted R Square -0.010309989 48 1.285824505-0.00113388 Standard Error 0.175956047 36 1.411515487 0.145675435 Observations 72 24 1.595824058 0.187308584 ANOVA df SS MS F Significance F Regression 1 0.008528411 0.008528411 0.275460755 0.601350276 Residual 70 2.167237127 0.03096053 Total 71 2.175765538 Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0% Intercept 0.024528183 0.020822149 1.177985177 0.242791802-0.017000283 0.066057-0.017 0.066057 X Variable 1-0.314123352 0.598508547-0.524843553 0.601350276-1.507810993 0.879564-1.50781 0.879564 SUMMARY OUTPUT Regression Statistics Multiple R 0.047413939 R Square 0.002248082 Adjusted R Square -0.014954538 Standard Error 0.190430055 Observations 60 ANOVA df SS MS F ignificance F Regression 1 0.004739 0.004739 0.130683 0.719039 Residual 58 2.103289 0.036264 Total 59 2.108028 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.028421194 0.025431 1.117597 0.268347-0.02248 0.079326-0.02248 0.079326 X Variable 1-0.341492122 0.944652-0.3615 0.719039-2.23242 1.549435-2.23242 1.549435 SUMMARY OUTPUT Regression Statistics Multiple R 0.142010005 R Square 0.020166841 Adjusted R Square -0.001133879 Standard Error 0.1941265 Observations 48 ANOVA df SS MS F ignificance F Regression 1 0.035679 0.035679 0.946768 0.335632 Residual 46 1.733515 0.037685 Total 47 1.769194 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0% Intercept 0.02909099 0.028845 1.008522 0.31848-0.02897 0.087153-0.02897 0.087153 X Variable 1 1.285824505 1.321478 0.97302 0.335632-1.37417 3.945822-1.37417 3.945822 SUMMARY OUTPUT Regression Statistics Multiple R 0.471850605 R Square 0.222642994 Adjusted R Square 0.187308584 Standard Error 0.062563227 Observations 24 ANOVA df SS MS F ignificance F Regression 1 0.024663 0.024663 6.301025 0.019919 Residual 22 0.086111 0.003914 Total 23 0.110775 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.00742423 0.013456 0.551733 0.586693-0.02048 0.035331-0.02048 0.035331 X Variable 1 1.595824058 0.63574 2.510184 0.019919 0.27738 2.914268 0.27738 2.914268 SUMMARY OUTPUT Regression Statistics Multiple R 0.412413273 R Square 0.170084708 Adjusted R Square 0.145675435 Standard Error 0.068619816 Observations 36 ANOVA df SS MS F ignificance F Regression 1 0.03281 0.03281 6.968037 0.012436 Residual 34 0.160095 0.004709 Total 35 0.192905 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.012185863 0.011797 1.033004 0.308894-0.01179 0.036159-0.01179 0.036159 X Variable 1 1.411515487 0.534725 2.639704 0.012436 0.324824 2.498207 0.324824 2.498207 120

5 year SUMMARY OUTPUT Regression Statistics Beta R2 adj Multiple R 0.063298568 72-0.31732611-0.01022177 R Square 0.004006709 60-0.35171084-0.0148228 Adjusted R Square -0.010221767 48 1.2535968-0.00214123 Standard Error 0.175948364 36 1.406613623 0.144434248 Observations 72 24 1.591537136 0.186122665 ANOVA df SS MS F ignificance F Regression 1 0.008717659 0.008717659 0.281597891 0.597335 Residual 70 2.16704788 0.030957827 Total 71 2.175765538 Coefficients Standard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.024366387 0.020794296 1.171782227 0.245257415-0.01711 0.065839-0.01711 0.065839 X Variable 1-0.31732611 0.597986126-0.53065798 0.59733539-1.50997 0.87532-1.50997 0.87532 SUMMARY OUTPUT Regression Statistics Multiple R 0.048760513 R Square 0.002377588 Adjusted R Square -0.014822799 Standard Error 0.190417696 Observations 60 ANOVA df SS MS F ignificance F Regression 1 0.005012 0.005012 0.138229 0.711403 Residual 58 2.103016 0.036259 Total 59 2.108028 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.028333885 0.025326 1.118761 0.267854-0.02236 0.07903-0.02236 0.07903 X Variable 1-0.351710841 0.94599-0.37179 0.711403-2.24532 1.541894-2.24532 1.541894 SUMMARY OUTPUT Regression Statistics Multiple R 0.138495216 R Square 0.019180925 Adjusted R Square -0.002141229 Standard Error 0.194224141 Observations 48 ANOVA df SS MS F ignificance F Regression 1 0.033935 0.033935 0.899577 0.347852 Residual 46 1.735259 0.037723 Total 47 1.769194 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.029639375 0.028766 1.030348 0.308234-0.02826 0.087543-0.02826 0.087543 X Variable 1 1.2535968 1.321717 0.94846 0.347852-1.40688 3.914076-1.40688 3.914076 SUMMARY OUTPUT Regression Statistics Multiple R 0.410948883 R Square 0.168878984 Adjusted R Square 0.144434248 Standard Error 0.068669644 Observations 36 ANOVA df SS MS F ignificance F Regression 1 0.032578 0.032578 6.908603 0.012783 Residual 34 0.160328 0.004716 Total 35 0.192905 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.012306145 0.011796 1.043207 0.304214-0.01167 0.036279-0.01167 0.036279 X Variable 1 1.406613623 0.535155 2.628422 0.012783 0.319048 2.49418 0.319048 2.49418 SUMMARY OUTPUT Regression Statistics Multiple R 0.470647039 R Square 0.221508636 Adjusted R Square 0.186122665 Standard Error 0.062608858 Observations 24 ANOVA df SS MS F ignificance F Regression 1 0.024538 0.024538 6.259787 0.02028 Residual 22 0.086237 0.00392 Total 23 0.110775 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.007386508 0.013474 0.548196 0.589077-0.02056 0.03533-0.02056 0.03533 X Variable 1 1.591537136 0.636117 2.501957 0.02028 0.272311 2.910763 0.272311 2.910763 121

7 year SUMMARY OUTPUT Regression Statistics Multiple R 0.063221544 R Square 0.003996964 Adjusted R Square -0.010231651 Standard Error 0.035058212 Observations 72 ANOVA df SS MS F ignificance F Regression 1 0.000345261 0.000345 0.28091 0.597782 Residual 70 0.086035474 0.001229 Total 71 0.086380735 Coefficients Standard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.002659091 0.004169355 0.63777 0.525704-0.00566 0.010975-0.00566 0.010975 X Variable 1-0.012597011 0.023767511-0.53001 0.597782-0.06 0.034806-0.06 0.034806 SUMMARY OUTPUT Regression Statistics Multiple R 0.048511097 R Square 0.002353327 Adjusted R Square -0.014847478 Standard Error 0.026384089 Observations 60 ANOVA df SS MS F ignificance F Regression 1 9.52E-05 9.52E-05 0.136815 0.712815 Residual 58 0.040375 0.000696 Total 59 0.04047 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.006382052 0.003439 1.85581 0.068564-0.0005 0.013266-0.0005 0.013266 X Variable 1-0.006721568 0.018172-0.36988 0.712815-0.0431 0.029654-0.0431 0.029654 SUMMARY OUTPUT Regression Statistics Multiple R 0.137711215 R Square 0.018964379 Adjusted R Square -0.002362483 Standard Error 0.021464445 Observations 48 ANOVA df SS MS F ignificance F Regression 1 0.00041 0.00041 0.889225 0.350614 Residual 46 0.021193 0.000461 Total 47 0.021603 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.00417158 0.003151 1.323721 0.192137-0.00217 0.010515-0.00217 0.010515 X Variable 1 0.015217308 0.016137 0.942987 0.350614-0.01727 0.0477-0.01727 0.0477 Regression Statistics Multiple R 0.411136896 R Square 0.169033547 Adjusted R Square 0.144593357 Standard Error 0.020071692 Observations 36 ANOVA df SS MS F ignificance F Regression 1 0.002786 0.002786 6.916213 0.012738 Residual 34 0.013698 0.000403 Total 35 0.016484 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.002873003 0.003466 0.828977 0.4129-0.00417 0.009916-0.00417 0.009916 X Variable 1 0.120183827 0.0457 2.629869 0.012738 0.027311 0.213056 0.027311 0.213056 SUMMARY OUTPUT Regression Statistics Multiple R 0.469840251 R Square 0.220749861 Adjusted R Square 0.185329401 Standard Error 0.018530049 Observations 24 ANOVA df SS MS F ignificance F Regression 1 0.00214 0.00214 6.23227 0.020526 Residual 22 0.007554 0.000343 Total 23 0.009694 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.004183488 0.003914 1.068878 0.296713-0.00393 0.0123-0.00393 0.0123 X Variable 1 0.138988693 0.055675 2.496451 0.020526 0.023527 0.254451 0.023527 0.254451 122

10 year SUMMARY OUTPUT Regression Statistics Beta R2 adj Multiple R 0.000369763 72 0.186153039-0.01428558 R Square 1.36725E-07 60-0.63719401-0.01724019 Adjusted R Square -0.014285576 48-97.0027287-0.00334164 Standard Error 0.176301902 36-46.8776409-0.00057854 Observations 72 24-84.4515431 0.008036467 ANOVA df SS MS F Significance F Regression 1 2.97481E-07 2.97481E-07 9.57074E-06 0.997540419 Residual 70 2.175765241 0.031082361 Total 71 2.175765538 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.02284719 0.224478994 0.101778745 0.919223281-0.42486204 0.470556421-0.42486204 0.470556421 X Variable 1 0.186153039 60.17239273 0.003093662 0.997540419-119.8238986 120.1962046-119.8238986 120.1962046 SUMMARY OUTPUT Regression Statistics Multiple R 0.001079227 R Square 1.16473E-06 Adjusted R Square -0.017240194 Standard Error 0.190644356 Observations 60 ANOVA df SS MS F ignificance F Regression 1 2.46E-06 2.46E-06 6.76E-05 0.99347 Residual 58 2.108026 0.036345 Total 59 2.108028 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0% Intercept 0.028399616 0.284577 0.099796 0.920851-0.54124 0.598043-0.54124 0.598043 X Variable 1-0.637194009 77.52551-0.00822 0.99347-155.821 154.547-155.821 154.547 SUMMARY OUTPUT Regression Statistics Multiple R 0.134186643 R Square 0.018006055 Adjusted R Square -0.003341639 Standard Error 0.194340432 Observations 48 ANOVA df SS MS F ignificance F Regression 1 0.031856 0.031856 0.843466 0.363198 Residual 46 1.737337 0.037768 Total 47 1.769194 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0% Intercept 0.399396275 0.396939 1.006191 0.319588-0.3996 1.198393-0.3996 1.198393 X Variable 1-97.00272867 105.621-0.9184 0.363198-309.607 115.6013-309.607 115.6013 SUMMARY OUTPUT Regression Statistics Multiple R 0.16736 R Square 0.028009 Adjusted R Square -0.00058 Standard Error 0.074261 Observations 36 ANOVA df SS MS F ignificance F Regression 1 0.005403 0.005403 0.979763 0.32925 Residual 34 0.187502 0.005515 Total 35 0.192905 Coefficientstandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept 0.198097 0.180535 1.09728 0.28023-0.16879 0.564988-0.16879 0.564988 X Variable 1-46.8776 47.3593-0.98983 0.32925-143.123 49.36804-143.123 49.36804 SUMMARY OUTPUT Regression Statistics Multiple R 0.226197517 R Square 0.051165317 Adjusted R Square 0.008036467 Standard Error 0.069120068 Observations 24 ANOVA df SS MS F ignificance F Regression 1 0.005668 0.005668 1.186336 0.287858 Residual 22 0.105107 0.004778 Total 23 0.110775 Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0% Intercept 0.351616348 0.30656 1.146974 0.263714-0.28415 0.987383-0.28415 0.987383 X Variable 1-84.45154306 77.53605-1.08919 0.287858-245.251 76.34839-245.251 76.34839 123

Discounted Dividends Approach WACC(BT) 0.0852 Kd 0.0474 Ke 0.157 Perp 0 1 2 3 4 5 6 7 8 9 10 11 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS (Earnings P 7.72 7.51 8.03 8.60 9.20 9.84 10.53 11.27 11.91 12.90 13.80 DPS (Dividends 0.45 0.53 0.61 0.69 0.77 0.85 0.93 1.01 1.09 1.17 1.25 1.33 BPS (Book Value 39.88 46.86 54.29 62.19 70.62 79.61 89.21 99.47 110.29 122.02 134.57 Cash From Oper 4312906.00 4724604.03 5055326.31 5409199.15 5787843.09 6192992.11 6626501.56 7090356.67 7586681.64 8117749.35 8685991.80 Cash Investmen -5775582.00-5891093.64-6008915.51-6129093.82-6251675.70-6376709.21-6504243.40-6634328.27-6767014.83-6902355.13-7040402.23 PV Factor 0.6061 0.3673 0.2226 0.1349 0.0818 0.0496 0.0300 0.0182 0.0110 0.0067 PV Dividends Year by Year 0.32 0.22 0.15 0.10 0.07 0.05 0.03 0.02 0.01 0.01 Total PV of Annu 0.99 Continuing (Terminal) Value Perpetuity 2.046153846 PV of Terminal V 0.0137 Estimated Price 1.0035 Growth Time consistent $1.52 0 0.02 0.04 0.06 0.08 0.09 Observed Share $99.18 0.1 $11.06 $12.45 $14.76 $19.39 $33.27 $61.02 Initial Cost of Eq 0.65 0.12 $8.99 $9.78 $10.95 $12.92 $16.84 $20.76 Perpetuity Grow 0 ke 0.14 $7.55 $ 8.02 $8.69 $9.69 $11.36 $12.69 0.157 $6.62 $6.95 $7.39 $8.00 $8.94 $9.61 0.18 $5.67 $5.88 $6.14 $6.48 $6.97 $7.29 0.2 $5.04 $5.18 $5.35 $5.57 $5.87 $6.06 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% 124

Free Cash Flows Approach WACC(BT) 0.0852 Kd 0.0474 Ke 0.157 0 1 2 3 4 5 6 7 8 9 10 11 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3987666 4266803 4565479 DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334044.37 360503.33 386962.29 413421.25 439880.21 BPS 13191053.00 15849662.00 18708562.00 21779921.00 25076760.00 28613010.00 32403578.00 36464413.00 40812583.00 45466348.00 50445249.00 Cash From Operations 4312906 4724604.03 5055326.312 5409199.154 5787843.095 6192992.111 6626501.559 7090356.668 7586681.635 8117749.35 8685991.804 9294011.2 Cash Investments -5775582.00-5891093.64-6008915.513-6129093.823-6251675.7-6376709.214-6504243.398-6634328.266-6767014.831-6902355.128-7040402.23 Book Value of Debt and Preferred Stock $11,216 Annual Free Cash Flow 10615697.67 11064241.82 11538292.98 12039518.79 12569701.32 13130744.96 13724684.93 14353696.47 15020104.48 15726394.03 9294011.2 PV Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39 PV of Free Cash Flows 9650634.25 9144001.51 8668890.29 8223153.33 7804795.58 7411963.21 7042933.49 6696105.33 6369990.54 322.00 Total PV of Annual Free Cash Flows 71012789.53 Continuing (Terminal) Value Perpetuity -128007313 PV of Terminal Value Perpetuity -49352360.63 Value of Firm 21660428.90 Book Value of Liabilities $11,216 Growth Estimated Market Value of Equity $21,649,213.39 0 0.02 0.03 0.04 0.045 Number of Shares 330737 0.05 $ 7.64 $ (178.89) $ (412.05) $ (1,111.55) $ (2,510.53) Estimated Price per Share (end of 2006) $65.46 0.06 $ 62.23 $ (43.81) $ (149.85) $ (361.93) $ (574.00) Time Consistent implied price $70.07 WACC 0.07 $ 96.56 $ 30.36 $ (27.56) $ (124.09) $ (201.32) Observed Share Price $99.18 0.0852 $ 126.84 $ 90.62 $ 62.67 $ 22.35 $ (5.33) Initial WACC 0.1 0.09 $ 132.91 $ 102.35 $ 79.43 $ 47.34 $ 25.95 Perpetuity Growth Rate (g) 0.045 0.1 $ 141.96 $ 119.99 $ 104.30 $ 83.38 $ 70.17 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% 125

Residual Income Approach WACC(BT) 0.0852 Kd 0.0474 Ke 0.157 Change in RI -188528.30-199496.87-211524.97-224686.21-239059.62-254728.26-321786.22-232477.54-311458.99-219612.44 0 1 2 3 4 5 6 7 8 9 10 11 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3937666 4266803 4564479 DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334044.37 360503.33 386962.29 413421.25 439880.21 BPS 13191053 15499080 17954481 20569423 23356928 26330925 29506322 32899069 36476231 40356072 44507130 Put in your total forecast Net Income 2483318.00 2657150.00 2843151.00 3042172.00 3255124.00 3482982.00 3726791.00 3937666.00 4266803.00 4564479.00 "Normal" (Benchmark) Earnings 2070995.32 2433355.62 2818853.49 3229399.46 3667037.66 4133955.28 4632492.54 5165153.77 5726768.30 6335903.30 Residual Income (Annual) 412322.68 223794.38 24297.51-187227.46-411913.66-650973.28-905701.54-1227487.77-1459965.30-1771424.30-1991036.74 PV Factor, Discount Factor 0.83 0.69 0.58 0.48 0.40 0.33 0.28 0.23 0.19 0.16 0.13 PV of Annual Residual Income 343602.23 155412.76 14061.06-90291.02-165538.86-218009.63-252764.68-285474.42-282951.06-286094.91-267969.62 Total PV of Annual Residual Income -1068049 Continuing (Terminal) Value Perpetuity -595488.05 PV of Terminal Value Perpetuity -96174.65 Growth Initial Book Value of Equity 13191053 0-0.05-0.1-0.15-0.2-0.25 Market value of Total Equity 0.1 $ 26.15 $ 29.08 $ 30.55 $ 31.43 $ 32.02 $ 32.44 Estimated Price per Share (end of 200 12026829.82 0.12 $ 31.68 $ 33.18 $ 34.00 $ 34.52 $ 34.87 $ 35.13 Time consistent implied by model $ 42.33 ke 0.14 $ 35.39 $ 36.19 $ 36.66 $ 36.97 $ 37.19 $ 37.35 Observed Share Price $99.18 0.157 $ 37.72 $ 38.21 $ 38.51 $ 38.71 $ 38.86 $ 38.97 Initial Cost of Equity (You Derive) 0.2 0.18 $ 40.18 $ 40.44 $ 40.61 $ 40.72 $ 40.81 $ 40.87 Perpetuity Growth Rate (g) -0.25 0.2 $ 41.91 $ 42.06 $ 42.16 $ 42.23 $ 42.29 $ 42.33 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% 126

Long Run Residual Income Perpertuity Book Value of Equity 13191053 Overvalued > 114.06 Cost of Equity 0.2 0.157 Undervalued < 84.30 Return on Equity (AVG) 0.23 0.18602 Fairly Valued Within 15% Growth 0.17765 0.17765 Price 30897164 Price Per Share 93.42 Observed Share Price (11/1/06) $99.18 Growth 0.14 0.16 0.18 0.2 0.22 0.15 $ 23.46 $ 132.95 $ 52.02 $ 46.38 $ 44.32 ROE 0.17 $ 70.38 $ (132.95) $ 17.34 $ 27.83 $ 31.65 0.19 $ 117.31 $ (398.84) $ (17.34) $ 9.28 $ 18.99 0.21 $ 164.23 $ (664.73) $ (52.02) $ (9.28) $ 6.33 0.23 $ 211.15 $ (930.62) $ (86.70) $ (27.83) $ (6.33) Ke 0.12 0.14 0.16 0.18 0.2 0.15 $ 19.13 $ 29.29 $ 62.48 $ (469.27) $ (49.34) ROE 0.17 $ 5.29 $ 8.10 $ 17.29 $ (129.83) $ (13.65) 0.19 $ (8.54) $ (13.08) $ (27.91) $ 209.60 $ 22.04 0.21 $ (22.38) $ (34.27) $ (73.10) $ 549.04 $ 57.73 0.23 $ (36.22) $ (55.46) $ (118.30) $ 888.48 $ 93.42 Growth 0.13 0.15 0.17 0.19 0.21 0.12 $ (223.43) $ (47.89) $ (12.78) $ 2.27 $ 10.63 Ke 0.14 $ 223.43 $ (143.66) $ (21.30) $ 3.17 $ 13.66 0.16 $ 74.48 $ 143.66 $ (63.89) $ 5.29 $ 19.13 0.18 $ 44.69 $ 47.89 $ 63.89 $ 15.87 $ 31.88 0.2 $ 31.92 $ 28.73 $ 21.30 $ (15.87) $ 95.64 127

AEG Approach WACC(BT) 0.0852 Kd 0.0474 Ke 0.157 0 1 2 3 4 5 6 7 8 9 10 11 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3937666 4266803 4564479 DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334014.07 360503.33 386962.29 413421.25 439880.21 DPS invested at 15.7% (Drip) 23366.57 27520.63 31674.68 35828.74 39982.80 44136.85 48290.91 52440.21 56599.02 60753.08 Cum-Dividend Earnings 2506684.57 2684670.63 2874825.68 3078000.74 3295106.80 3527118.85 3775081.91 3990106.21 4323402.02 4625232.08 Normal Earnings 2953185.81 2873198.93 3074322.55 3289525.71 3519793.00 3766178.47 4029810.17 4311897.19 4555879.56 4936691.07 Abnormal Earning Growth (AEG) -446501.24-188528.30-199496.87-211524.97-224686.21-239059.62-254728.26-321790.98-232477.54-311458.99-242639.08 PV Factor 0.86 0.75 0.65 0.56 0.48 0.42 0.36 0.31 0.27 0.23 PV of AEG -385912.91-140834.75-128805.97-118039.73-108370.14-99656.60-91779.06-100209.06-62572.11-72454.82 Residual Income Check Figure Annual Residual Income 412322.68 223794.38 24297.51-187227.46-411913.66-650973.28-905701.54-1227487.77-1459965.30-1771424.30-1991036.74 Change in Residual Income -188528.30-199496.87-211524.97-224686.21-239059.62-254728.26-321786.22-232477.54-311458.99-219612.44 Core EPS 2552451.00 Total PV of AEG (1,308,635.15) Growth Continuing (Terminal) Value 0-0.05-0.1-0.15-0.2-0.25 (564,276.93) PV of Terminal Value (131,267.95) 0.1 $ 22.24 $ 28.40 $ 31.48 $ 33.33 34.56 35.44 Total PV of AEG (1,439,903.10) 0.12 $ 21.42 $ 25.25 $ 27.34 $ 28.65 29.56 30.22 Total Average EPS Perp (t+1) 1,112,547.90 ke 0.14 $ 20.25 $ 22.81 $ 24.30 $ 25.27 25.96 26.48 Capitalization Rate (perpetuity) 0.180 0.157 $ 19.23 $ 21.12 $ 22.27 $ 23.05 23.61 24.03 0.18 $ 17.94 $ 19.25 $ 20.10 $ 20.68 21.12 21.45 Intrinsic Value Per Share (end 1987) 6180821.65 time consistent implied price 21.45 Observed price $ 99.18 Ke 0.180 g -0.25 Actual Price per share $ 99.18 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15% 128

Z-Score Analysis Z-Score = 2002 2003 2004 2005 2006 1.2 (Working Capital/Total Assets) 234546 78694 65891-24487 303707 9459851 12416126 15502480 19271796 24308175 + 1.4 (Retained Earnings/Total Assets) 1427607 2445698 4017339 6516863 8898577 9459851 12416126 15502480 19271796 24308175 + 3.3 (EBIT/Total Assets) 898970 1922257 2663083 4206254 4009595 9459851 12416126 15502480 19271796 24308175 + 0.6 (Market Value of Equity/Book Value of Equity) 17837870 26357500 16936499 22713600 32875257 4535521 5883328 7298059 8730581 11117112 + 1.0 (Sales/Total Assets) 2559873 4190299 5332577 7584244 8288779 9459851 12416126 15502480 19271796 24308175 WEIGHTED 2002 2003 2004 2005 2006 0.0298 0.0076 0.0051-0.0015 0.015 0.2113 0.276 0.3628 0.4734 0.5125 0.6359 0.6629 0.6125 0.7203 0.6751 2.3597 2.688 1.3924 1.5869 1.7743 0.2706 0.3375 0.344 0.3935 0.341 2002 2003 2004 2005 2006 2006 Z-Score 3.51 3.97 2.72 3.13 3.32 3.32 129

References 1. Apache Oil Corporation website: www.apachecorp.com 2006 Annual Report 2006 10-K 2. Independent Petroleum Association of America website: www.ipaa.org 3. Consumer Reports website: www.consumerreports.org 4. Wikipedia website: www.wikipedia.com 5. Encyclopedia website: www.encylopedia.com 6. Securities information website: www.secinfo.com 7. Investing Business Week website: www.investing.businessweek.com 8. CNN website: www.cnn.com 130

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