Relationship Of The Article To The Topic Article Reviews Example
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“Chesapeake Energy Cuts Capital Budget, Production Outlook”, Wall Street Journal, March 24, 2015
Chesapeake lowered its 2015 capital budget by not less than 10%. In addition, it sharply reduced its production outlook and became the largest energy company to do so responding to reduced prices of oil (Beilfuss 1). In relation to the chapter, capital budgeting involves the process in which the management decides the productive areas for investments. Capital expenditure consists of a remarkable quantity of money and, therefore, crucial to the achievement of the firm’s strategic plans. The company analyzed its profitability in the long run and therefore decided to take the most appropriate decision of cutting down the capital budget. The company found that its internal rate of return may reduce and thus made a decision before it becomes too late.
Tycoon Carl Icahn amplified his stake in Chesapeake Energy from 10% to about 11%. He currently owns 73.1 million shares of Chesapeake as shown by financial filing. However, he is not the largest investor of the company (Beilfuss 1). In relation to the chapter, the net present value helps the investors in making decisions. It shows by how much present capital will increase the value of the dollar in the future. Carl found that the net present value of the company had consistency with his requirements and thus decided to increase his stake in the company. However, he is not the largest investor since he does not trust the accounting rate of return since it is the basis of the book value and income instead of cash flows. The returns may not be real, and thus he takes the precautions since they may change any time.
The article highlights important aspects on the topic of capital budgeting. Firstly, capital spending must be justified with adequate returns. The oil companies are reducing capital expenditure and drilling activities in response to falling oil prices. The viability of the capital expenditures depends on the oil prices. As shown in the examples on this topic, a reduction in the price of the product will cause a reduction in revenues. It then causes a reduction in the cash flows expected from the expenditures. In order to enhance profitability, the capital spending must be reduced if the cash flows and revenues are expected to fall. The aim of capital budgeting decisions is to increase shareholders’ wealth. It can only be done if the company’s projects are profitable. Carl Icahn increased its shareholding in Chesapeake Corporation from 10% to about 11% (Beilfuss 1). The investor must have been expecting better returns from the company. The management of the company must, therefore, ensure that the company’s capital expenditure generates adequate cash flows.
The falling prices reduce cash flows hence to maintain the returns and the net present value of the project, the company had to cut the capital budget. Holding other factors constant, a reduction in the cost of an investment leads to an increase in the investment’s NPV, IRR, profitability index, payback period and accounting return. The management of the Chesapeake must have determined the NPV and IRR of capital expenditure and calculated the amount of capital spending that would maintain profitability at its current level.
Beilfuss, Lisa. 'Chesapeake Energy Cuts Capital Budget, Production Outlook'. WSJ. N.p., 2015. Web. 11 Apr. 2015.
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