Financial model

Case Study - Star Oil & Gas

Mo Alkassar was considering buying some stock in Star Oil & Gas Corporation for a portfolio he

manages. Star O&G shares had declined significantly since the beginning of the year. A recent Star O&G

meeting indicated management wanted to revitalize the company, including top line and operating

performance. To boost sales, the company was going to produce more oil in the Permian. Star O&G

planned to also expand holdings in the Eagleford, which has been performing extremely well. Star O&G

would also work on controlling costs and expenses. Star O&G managers reiterated their long term

growth targets of 9-10% in revenue and earnings growth of 15%.

Mo read the analysis reports and they were mixed in their opinions and gave no clear guidance.

Mo decided to develop his own cash flow forecast to make a decision. His forecast showed that at a

discount rate of 12%, Star O&G was overvalued at its current stock price ($42). But, after he performed

a sensitivity analysis, he determined that Star O&G was undervalued at discount rates below 11%. Mo

decided to ask his newly hired assistant, James Shaw (a finance graduate from MSU), to estimate Star

O&G’s cost of capital.

James gathered the following data to determine if Star Oil & Gas was undervalued or

overvalued.