Calculate super normal profit, Financial Management

The economic analysis is done for Schlumberger, oilfield service company. They are # 1 in terms of market caps, revenue and employees globally. If any references are used / outside sources (except for Schlumberger's annual reports and financial statements), they should be clearly stated.

4 things should be done:

1. Calculate Super Normal Profit

2.Effects of inflation on revenue

3. Determine Price Elasticity of Demand ( see below - I concluded it is inelastic but need to see additional ideas / reasoning)

4.Generic comment on financial health / wealth generating potential ( based on balance sheet)

Details and explanation:

1. Calculate Super Normal profit : calculate exactly the % of super normal profit Schlumberger is making. Use 5 year average, as well as 2009 data separately, and Q 3 2010 ( it was announced on Fri). Plot 3 simple graphs to show, or these three in one graph is also okay.

That would require to compare ROCE ( return on capital employed) or RONA ( return on net assets) - preferably ROCE, with long term government bond / interest rate / rate of return in financial markets. It is OK to use US rate as benchmark - they are international and report everything in $, plus there is no currency-specific regional breakdown in the financial reports.

The 10 year bond yield (the long bond yield) is the rate that should be used for the calculation of normal and supernormal profit. This is built into the LRATC curve as an implicit cost of being in that business- any profits earned above that yield are classed within economic theory as supernormal.A firm makes normal profits if the rate of return equals the opportunity cost of the business activity. The simplest indicator of that is the rate of return in the financial markets on a low risk financial asset. If ROCE exceed that rate the firm makes 'supernormal profits'

The way ROCE should be calculated

Operating Profit/(ave total assets - current liabilities) x 100


Profit before tax/ (total assets - current liabilities) x 100

- need to use operating profit margin to determine rate of return

-based on that need to conclude whether a company is in ' strategic hell' ( presumably not based on calculation) - conclude that by assessing the performance of a firm in terms of its ability to escape strategic hell

If they can't calculate ROCE they can use RONA. Some websites provide RONA, they are somewhat different but if they pick off one of the websites ( eg forbes etc) they need to specify which one and stick to the same one.

2. Effects of inflation on revenue. Do that either using GDP calculator or industry indices ( eg. Dow Jones.) to calculate real versus nominal value. The industry they should look for is oilfield equipment and services. If they can't fine then oil and gas. Also, if they could draw a generic conclusion on exchange rates. (there are no specific breakdowns detailed enough. they operate globally, generate revenue in dollars, and oil is traded in dollars. I just need a generic conclusion on how exchange rates affect their revenue and not specific data for them to look at. Note: it should not be a conclusion on how oil trade is affected by exchange rates fluctiations ( i know that), but how revenues of a global oilfield service company are)

3. Price Elasticity of Demand (PED) for Schlumberger ( i.e. oilfield service). I am not sure how they can do it. One way is to compare average change in rig rates to average change in SLB stock price? They must note that the stock price was split in 2006 when it crossed a 100$. I think that the site that have historic stock price have already considered that in calculation. Or they can use any other way. I have concluded it is inelastic but I am not sure how to support that claim propertly.

4. Wealth generating potential. a few generic strategic sentences / one short paragraph, based on their balance sheet and net dept vs equity or cash flow. Treat it as part of investment appraisal exercise.

Supporting info:

Just as a reference key competitors considered here are Halliburton, Baker Hughes and Weatherford.

below is Schlumberger's revenue from 2009 - 2004 ( backwards), in $ US Billions:



2007: 23.28

2006: 19.23

2005: 14.31

2004: 11.5B

below is RONA from one of the websites for 5 year average ( need to double-check that figure):

Please note: this was as of Q 2 2010. For a 12 month period ending Q 2 2010 they had the following figure for RONA ( all is $ US billion)

Below is also an explanation on GDP deflator and how to convert nominal to real values:

At the business level the simplest solution to this problem is to deflate current total revenue ( ie the money value of output = P x Q ) by an appropriate index of prices .The GDP deflator can be viewed as a measure of aggregate prices in the domestic economy. The deflator is usually expressed in terms of an index, i.e. a time series of index numbers The GDP deflator reflects movements of hundreds of separate deflators for the individual expenditure/output components of GDP.

GDP deflator for specific economy should be used The IMF is the first port of call for this data but local sources can also be used. In the example 2003 is the base year so when TR ( the money value of output ) is deflated before 2003 the real value is higher ie at 2003 prices TR is higher in 2000 when it is valued at 2000 prices. After 2003 the opposite happens so the real value (' volume') is less than the current value. Government statisticians use this method to value company level real output which they can they aggregate to obtain a macro level measure ie GDP

GDP deflator is an average measure of prices In general, it is better when calculating real output at the company level to use either a company or sector specific price index. When this is not available the GDP deflator is a good alternative.

Posted Date: 2/25/2013 1:02:42 AM | Location : United States

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