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RIVERSTONE HOLDINGS LIMITED STOCK VALUATION REPORT AUGUST 13, 2014 TO PROFESSOR DAVID DING PRESENTED BY TEAM 4

Riverstone Holdings Ltd - Stock Valuation Report

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Page 1: Riverstone Holdings Ltd - Stock Valuation Report

RIVERSTONE HOLDINGS LIMITED STOCK VALUATION REPORT

AUGUST 13, 2014

TO PROFESSOR DAVID DING

PRESENTED BY TEAM 4

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RIVERSTONE HOLDINGS LIMITED

EXECUTIVE SUMMARY

FUTURE PLANS

Riverstone is expanding. It plans to upgrade facilities in Malaysia by increasing the number of

cleanrooms for laundry and packaging of our products, install additional cleanroom plant and

equipment and an additional dipping line by adding additional floor space to house additional plant

and equipment in Thailand, and expend the production facilities of Riverstone Industrial Malaysia

and Riverstone China.

Riverstone intends to enhance current product processes, penetrate new industries, expand sales

network and enhance brand awareness. They are building relationships with existing customers in

the HDD and semiconductor sectors within the electronics industry through joint efforts in product

development, participating in exhibitions and publishing advertisements in trade publications.

Riverstone also intends to grow business through joint ventures and acquisitions. It is exploring

investment opportunities through acquisitions, investments, strategic alliances and/or joint

ventures with suitable strategic partners.

CURRENT SITUATION

Riverstone is in a promising industry. Riverstone manufacture, source and market mainly nitrile and

natural rubber gloves primarily for use in a class 10 and class 100 cleanroom environment, also

Market Price: 0.915

Target Price: 2.82

BUY

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RIVERSTONE HOLDINGS LIMITED

other cleanroom consumable products comprising cleanroom packaging materials and finger cots.

There will always be a stable demand rubber whether the whole economy is in growth or recession.

In our report, we calculated that beta is 0.1854, which means that riverstone is inelastic with the

market.

Also, riverstone is one of the main medical glove manufacturers in malaysia. It has the advantage

of sticky clients, technology for complex cleanroom and nitrile gloves as well as a good reputation

on the market.

What is more, riverstone has a healthy financial status. The efficient management of its asset leads

to have a relevant high roe. Riverstone is increasing their working capital efficiency. The company

has enough current assets to meet its current liability, which means that they have less liquidity

risk.

BACKGROUND

A PIONEER IN CLEANROOM AND NITRILE GLOVES

Riverstone Holdings is a rubber glove manufacturer and one of the pioneers in cleanroom and Nitrile

gloves. It possesses a niche in the electronics cleanroom industry and has been focusing on this

industry since 1991. Riverstone was first established in 1989 and by the end of 1994, it became the

first manufacturer of cleanroom gloves in Asia, possessing a fully integrated production process. It

also became the first manufacturer of nitrile gloves in Malaysia that very same year. Four years

ago, Riverstone expanded into manufacturing medical nitrile gloves for the healthcare sector.

Based on its past experience in manufacturing nitrile gloves, the Company managed to deliver

customized gloves and thus, differentiated itself from the competition.

Riverstone has two main consumers as a rubber glove manufacturer. They are cleanroom users in

the electronics industries and healthcare workers in hospitals and clinics. Their distribution

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RIVERSTONE HOLDINGS LIMITED

channels would be through RS Riverstone Resource brand for cleanroom products and medical

supplies vendors for healthcare products.

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RIVERSTONE HOLDINGS LIMITED

HISTORICAL ANALYSIS FOR RIVERSTONE (JAN 2009 – DEC 2013)

We can see the stock price performance in the last five years from the chart above and explain

below the reasons for the major ups and lows:-

Point 1 (July, 2009) Since the global economy

faced recession, the fall is the result of the

lower demand for the Group’s products.

Point 2 (Feb, 2010) After Riverstone announced

that EPS of 3.56 sen against 1.88 sen a year ago

during last three months, ROE jumped to 17.2%

against 15.8% a year ago and ROA to 15.1%

against 14.2% a year ago, resulting in the share

price jumping to SGD 0.65.

Point 3 (Aug, 2011) Stock markets in Asia and

Australia plunge, having an in turn effect on the

Company’s share price.

Point 4 (May, 2012) The share price of

Riverstone increased by 26.8% primarily due to

higher sales of healthcare gloves which led the

revenue to increase by 13.7%.

Point 5 (Nov, 2013) Riverstone expanded its

production capacity to meet the increasing

demand of products especially in healthcare

gloves industry.

1

2

4

5

3

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SWOT ANALYSIS

INDUSTRIAL OUTLOOK

ENVIRONMENT

Malaysia is currently one of the largest rubber products exporter in the world and the world leader

in producing natural rubber and nitrile rubber gloves. Malaysian producers fulfill almost 50% of the

Strengths

•Established and reputable brand

•Ability and wilingness to meet customers' needs for customisation

•Niche business provides a wide moat

•Sound management ensures solid financial health

•Enlarging capacity provides growth opportunities and economies of scale

•Strong financial position and no long term debt

Weaknesses

•Expansion in healthcare gloves capacity may exert pricing pressure

•Inability to pass on full impact of any cost increase

Opportunities

•Demand for cleanroom gloves to stay healthy due to company’s niche in the premium market

•Demand for healthcare gloves to grow exponentially, driven by European customers diversifying their supplier base

•Wider opportunities from tablet and mobile device manufacturing

•Customised medical gloves to provide growth driver

Threats

•Upstream price fluctuations may lead to higher costs

•Exposure to forex volatility

•Slowdown in economy and semiconductor related manufacturing

•Higher raw material costs

•Foreign exchange risk

Rubber Product (in Thousand tonnes) 2008 2009 2010 2011 2012 2013

Other Gloves 5,991.92 6,279.86 7,930.10 8,817.02 9,489.20 9,363.22

Surgical Gloves 916.34 866.21 985.38 1,074.51 1,070.63 1,170.30

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RIVERSTONE HOLDINGS LIMITED

global demand of medical gloves. Last year, Malaysia exported RM10.5 billion worth of medical-

related gloves and is globally renowned for its high quality and competitively priced rubber products.

POLITICAL AND LEGAL

Comparing Malaysia to her surrounding countries of Thailand and Indonesia; Malaysia has a more

stable political system as well as better R&D. The logistic infrastructure is also better in Malaysia

compared to her neighboring countries.

Next, there is an Economic Transformation Program (ETP) Malaysian government to transform their

economy by 2020. Under ETP, Malaysian rubber sector will not only maintain its hectares at one

million hectares but there will be additional zones of one million hectares by exploiting appropriate

land bank in Sabah and Sarawak. There are also replanting activities, which increased to 40,000ha

from 20,000ha per year.

This ensures that companies in Malaysia that produce rubber products will have continual access to

good local rubber supplies at competitive prices. The low logistical cost of transportation will also

be maintained.

0.00

1,000.00

2,000.00

3,000.00

4,000.00

5,000.00

6,000.00

7,000.00

8,000.00

9,000.00

10,000.00

Other Gloves

Gloves

Malaysian rubber products manufacturers

include MNCs and joint ventures from

numerous countries including the USA,

Europe and Japan and local small medium

enterprises (SMEs). On the left is a chart

showing the sales from Malaysia from 2008

to 2013.

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RIVERSTONE HOLDINGS LIMITED

ECONOMIC FACTORS

In addition, according to the McIlvaine Company’s report World Cleanroom Markets, Asia is

projected to be the largest buyers’ hub by 2015 for cleanroom consumables. The region is currently

the fastest growing across the globe in both consumables and hardware segments. It is forecasted

that cleanrooms consumables sales will surpass $8 billion through 2015 with

biotechnology/pharmaceutical sectors being the third largest consumers of cleanroom products.

What this means is that there will be continual demand for the products that Riverstone produces.

TECHNOLOGY

Due to the expansion of technology, more companies will be experiencing a greater demand for

high technologic gloves such as Nitrile gloves, which forms a large part of RIverstone’s business.

The barrier to entry is high, as manufacturing such gloves requires a three-step process that

competitors might not have the expertise in.

The raise in demand for smart phones and tablets in turn increases the demands for Nitrile /

Cleanroom gloves which leads us to believe that in the next five years, Riverstone will have a

healthy growth rate.

COMPETITORS

The major competitors of Riverstone include Supermax Corporation Berhad and Kossan Rubber

Industries Berhad. We provide slight background of these competitors below.

Supermax Corporation Berhad

Supermax Corporation Berhad was founded in 1987. It manufactures, distributes, and markets

medical gloves in Malaysia. It provides powdered and powder free latex examination gloves, powder

free nitrile examination gloves, and latex surgical gloves. The company is also involved in the

trading of gloves. The company, listed on the Main Board of Bursa Malaysia Securities, sells its

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products to laboratories, hospitals, pharmacists, doctors, and surgeons under the Supermax, Aurelia,

Maxter, Medic-dent, and Supergloves brands. Similar to Riverstone, Supermax Corporation Berhad

also exports its products to approximately 145 countries in the regions of the United States, Europe,

the Middle East, Asia, and the South Pacific.

Kossan Rubber Industries Bhd

Kossan Rubber Industries Bhd was established in 1979. With a growing market demand for its

products, the company continued to progress rapidly and was one of the first companies in Malaysia

to venture into glove manufacturing. The company introduced the first glove production line in

August 1988 and is able to make 16 billion pieces of gloves per annum today.

While Riverstone focuses on the specialized cleanroom products, Kossan has two main product

categories that are latex gloves and technical rubber products. Similar with Riverstone, Kossan has

a business network that extends to the world. The market of Kossan extends to various places,

including the USA, Canada, Europe, Asia Pacific, Latin America, Middle East and Australia. This year,

Kossan’s earnings outperformed its peers. Results reflected its ability in passing on higher

electricity cost and the result of its ongoing automation effort. Elsewhere, higher pretax profit

from its cleanroom division partly offset the lower profit of its technical rubber product division.

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HISTORICAL PERFORMANCE RATIOS

PROFITABILITY ANALYSIS

Gross Profit Margin

As shown in the chart, gross profit

margins of Riverstone kept constant at

about 30% from 2009 to 2013, except

the lowest of 22.6% in 2011 in the past

five years. Kossan enjoyed the highest

gross profit margin, at about 40% among

these three companies during the past

five years, followed by Supermax at about 31%, slighter higher than Riverstone. Riverstone has the

lowest gross profit margin. All three companies experienced the lowest gross profit margin in 2011,

which is because of weaker US Dollar against Malaysian Ringgit, high raw materials prices and the

delay in passing on the higher costs to customers.

Return on Equity (ROE) and Return on Asset (ROA)

0

10

20

30

40

50

Dec-31-2009 Dec-31-2010 Dec-31-2011 Dec-31-2012 Dec-31-2013

Gross Profit Margin

Riverstone Kossan Supermax

0

5

10

15

20

25

30

ROE

Riverstone Kossan Supermax

0

2

4

6

8

10

12

14

ROA

Riverstone Kossan Supermax

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As shown above, Riverstone’s ROE was higher than Supermax’s after 2010. Also, its ROE was almost

constant at about 20% during the past five years, while both Kossan’s and Supermax’s ROE had big

fluctuations from 18% to 28% and from 13% to 26% respectively. This is mainly due to Riverstone’s

zero debt and efficient management. Also, as seen in Dupont analysis, ROE can be decomposed into

ROE = Profit Margin x Total Asset Turnover x Equity Multiplier = ROA x Equity Multiplier

Riverstone has highest ROA at about 11% compared to Kossan’s 10% and Supermax’s 7%, which

contributes to its high and stable ROE.

Although Riverstone’s gross profit margin is not the highest among the three companies, its ROE

still exceeds Supermax, ranking second. This mainly comes from its zero debt, efficient

management and high return in assets. Furthermore, in the rubber glove manufacturing industry,

the market needs are relatively stable and are not affected too much by an economic slowdown

and thus, the profits stay stable. So we have full confidence in forecasting Riverstone’s earnings in

following years due to its stable ROE.

TURNOVER RATIOS

0102030405060708090

Receivable Conversion Period

Riverstone Kossan Supermax

0

20

40

60

80

100

120

140

Inventory Conversion Period

Riverstone Kossan Supermax

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As shown above, Riverstone’s cash conversion cycle shows a downwards trend, reaching the lowest

point of 83.1 days in 2013. However, Kossan’s cash conversion cycle keeps constant at about 85

days and Supermax experiences a growing cash conversion cycle, even reaching the highest point

of 155.6 days in 2012. Riverstone can convert resource into cash within less days. This is because

of the constant downwards inventory conversion period, constant downwards receivable conversion

period and constant upwards payable conversion period. In recent years, Riverstone’s management

is an experienced, diligent yet conservative one, its working capital is getting increasingly used.

LIQUIDITY ANALYSIS

0

50

100

150

200

Cash Conversion Cycle

Riverstone Kossan Supermax

00.5

11.5

22.5

33.5

44.5

5

Quick Ratio

Riverstone Kossan Supermax

0

10

20

30

40

50

60

Payable Conversion Period

Riverstone Kossan Supermax

0

1

2

3

4

5

6

Current Ratio

Riverstone Kossan Supermax

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Compared to Kossan’s and Supermax’s stable current ratio and quick ratio, Riverstone has a U-

shape current ratio pattern and quick ratio pattern. Riverstone has the highest current ratio and

quick ratio mainly because of its high inventory and receivables. Also, with its expansion, it got

more inventories. Riverstone’s receivables kept accumulating because of its policy that customers

who are regular and prove to be creditworthy will be assigned a favourable credit term approved

by management.

In 2010, Riverstone expanded into the manufacturing of medical nitrile gloves for the healthcare

segment. The payables increased as a result of longer credit term granted by a few main suppliers

and contractors causing current liability to increase by 81.82%. So there was a sharp drop in both

current ratio and quick ratio in 2010 from 2009.

In 2011 and 2012, bigger increases in payables than in receivables led to both current ratio and

quick ratio to stay at a low position. However, the case was different in 2013. Current ratios

increased by almost 55% due to increase in sales activities and higher production volume, leading

to an increase in inventories and total receivables, while current liabilities dropped only by 10.69%

mainly due to lower payables which offset with the increase in derivatives and the increase in

provision of taxation. So both current ratio and quick ratio went back to about 4.8% and 4%

respectively.

As described, Riverstone has probably less exposure to liquidity risk. But high current ratio and

quick ratios are not necessarily good as it ties too much working capital in the current asset, which

could have been put to better used.

SOLVENCY ANALYSIS

As shown in the charts below, compared to Kossan’s and Supermax’s high long-term D/E or total

D/E, Riverstone has almost negligible debt. In 2010, it stopped borrowing or issuing bonds. Also, its

common stock increased in last 5 years indicating its high use of equity to finance its growth.

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Common Stock (in millions MYR)

Dec-31-2009 Dec-31-2010 Dec-31-2011 Dec-31-2012 Dec-31-2013

Riverstone 106.8 110.1 113.2 123.8 156.3

Without debt, Riverstone has a strong liquidity ability and has no interest expenses. Also, it is easier

for Riverstone to borrow from banks because of its financial stength. But zero debt is not necessarily

good. Zero debt means that Riverstone doesn’t use the leverage benefit.

RISK ANALYSIS

Riverstone Supermax Kossan

Beta 0.1854 0.2776 0.1232

Average rate of return (%) 0.2225 0.6943 0.3764

Standard deviation 0.0330 0.0669 0.0597

To evaluate the market risk of the stock of Riverstone, we used the MSCI World Index as the

market benchmark as Riverstone, Supermax and Kossan are all serving global clients. We used the

weekly rate of returns of Riverstone, Supermax and Kossan against MSCI World Index over a five-

year period and attained the beta of the three companies as shown on the table above. The below-

0

10

20

30

40

50

60

70

Total D/E

Riverstone Kossan Supermax

0

5

10

15

20

25

30

35

Long-term D/E

Riverstone Kossan Supermax

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1 beta of Riverstone showed that Riverstone tended to be less volatile than the market and thus a

relative low market risk. Both Supermax and Kossan had a below-1 beta as well.

Riverstone now is one of the major integrated manufacturers of cleanroom gloves in Asia. It

has established a stable business transaction record in the sector. Concurrently Riverstone is going

on an expansion spree, with planned production upgrades taking its capacity far above current

levels. Although this activity might increase the operating risk of Riverstone, but we feel that

Riverstone still had quite low risk because of its niche position in the cleanroom segment and has

room for growth.

However, comparing beta with the market benchmark is not enough to evaluate risk. We

obtained three companies’ average rate of return and the corresponding standard deviation using

a 5-year period. We found that Riverstone has the lowest rate of return and the lowest standard

deviation, which meant that Riverstone had the lowest risk associated with price-fluctuations in

the market.

Hence, we feel that Riverstone is an attractive investment for risk adverse investors.

COMPUTATION OF WEIGHTED AVERAGE COST OF CAPITAL (WACC)

To compute the WACC, we have assumed the risk free rate to be the Singapore government 10-year

bond yield of 2.46% and the market return of 13.56% by analysing the MSCI World Index past returns.

Thus, the required rate of return for Riverstone stock, using the Capital Asset Pricing Model, comes

out to be 4.5179%.

Rs = 2.46 + 0.1854 x (13.56 – 2.46) = 4.5179%

As the company has zero debt, the WACC is equal to the required return on stock, i.e. 4.5179%.

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VALUATION

DIVIDEND DISCOUNT MODEL (DDM)

V0 = D0(1+g)/(rs-g)

One of the methods we used was dividend discount model or the Gordon Growth Model as the

Company had been paying dividends for more than the last 5 years.

Year 2009 2010 2011 2012 2013

Dividend per share (MYR) 0.0430 0.0590 0.0590 0.0600 0.0680

Using the above dividends per share, the CAGR, g was computed as 6.43% per annum. Further, as

determined previously, the required return on stock is 4.5179%. However, these figures give us a

negative denominator in the dividend discount model and stocks don't have a negative value.

We have thus realized that DDM is not suitable for high growth companies such as Riverstone. Its

use is limited to firms that are growing at a stable rate. Also, DDM assumes that futures dividends

will grow at a stable rate in perpetuity, taking no account of the possibility that rapid near-term,

growth could be offset by slower further into the future. Due to all these limitations, DDM is not

suitable for valuation purposes.

P/E RATIO METHOD

* based on Yahoo Finance

** Forecast income statement

We got 0.89 using P/E ratio model but we do

not believe the intrinsic value is 0.89. This

model is suitable companies with a

comparable benchmark. Before exploring

more limitations about P/E ratio method, here

P/E ratio of industry* is 13.17. Earnings per share** is MYR0.17 Share price (MYR)=13.17 x 0.17 = 2.29 Share price (SGD)=2.29 x 0.39 = 0.89

P/E= Share Price/ EPS

10111213141516

P/E Ratio

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we introduce P/E ratio. P/E ratio is the price an investor is paying for $1 of a company's earnings.

Acknowledging that earnings is after interest and is the residual used for dividends and retained

earnings, meaning P/E ratio does not take into account capital structure. As we know, debt has a

leverage effect on the company. The stock price of non-zero debt company would have higher

volatility than that of zero debt company. Riverstone has a special capital structure- zero debt.

Considering this, we can’t compare Riverstone with Kossan, Supermax even the whole market.

P/E ratio assumes that the company have a stable earnings multiple and is thus more suitable for

mature companies. But Riverstone is in its developing stage. As below shown, Riverstone has a

fluctuating P/E ratio from 11 to 14.4 making this a not so reliable method of valuation.

FREE CASH FLOWS TO FIRM (FCFF) METHOD

The third method used to estimate the share price of the firm is FCFF method. In this method, we

have forecasted the income statement and the relevant balance sheet items to arrive at the free

cash flows for the next five years. Please refer to Appendices I to IV for the actual and forecast

financial statements. In computing the FCFF, we have made the following mjor assumptions:-

1. We have assumed the sales to grow for the next 5 years at the Compounded Annual Growth

Rate (CAGR) from the year 2009 to year 2013 of 23.13% p.a. Thereafter, from the 6th year

onwards, we have assumed the Company to grow at the economic growth rate and have

assumed it to be the US treasury 10-year bonds risk-free rate of 2.43%.

2. For the operating expenses/income items and working capital & other operating assets, we

have used the historical average of their respective percentages of sales from 2009 to 2013.

3. We have assumed the capital expenditure to grow at 17% p.a. which is the historical average

annual growth rate for the last five years.

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4. We have assumed the tax rate of 20% of Earnings before Tax (EBT) for the next 5 years.

Although corporate income tax rate in Malaysia is 25%, the historical average of the tax rates

for Riverstone has been a low of 12.81% of EBT and increased to 18% to 20% in 2012 and 2013.

Acknowledging that the Company will likely have tax reliefs given its capital expenditure

and for prudence, we have assumed the tax rate to be a high of 20% of EBT for next 5 years.

Using the above assumptions and necessary calculations, the results arrived at are summarized in

the table below. For detailed computation of the FCFF, please refer to Appendix V of the report.

* This value of PV is at beginning of Year 1 which is 31 December 2013. We have grown it back to 8 August 2014 by

multiplying by (1+0.045179)0.6027.

** 1MYR = S$0.3899 (Obtained from Monetary Authority of Singapore website)

As derived above, the share price of the Company should be S$2.82 using the FCFF method.

Compared to the PE ratio method and the Dividend Discount Model, we believe that the FCFF

method is most suited to companies such as Riverstone because it takes into consideration the high

growth in the short term and stable and slow growth in the long term. Therefore, we recommend

the share price of the Company to go up to $2.82 and thus, recommend a buy position.

Sensitivity Analysis

We have done a sensitivity analysis analysis to determine the impact on the shareprice due to

changes in a few key input variables.

2014 2015 2016 2017 2018

Currency (in millions) MYR MYR MYR MYR MYR

Free cash flow to firm (FCFF) 4.89 25.85 34.99 46.75 61.86

Discount factor (at 4.5179% WACC) 1.0452 1.0924 1.1418 1.1934 1.2473

Present value (PV) of FCFF 4.68 23.66 30.64 39.17 49.60

Total PV of five year FCFF 147.75

Terminal value 3,079.92

PV of terminal value 2,469.27

PV of total FCFF* (in millions MYR) 2,617.02

Total PV on 8 August 2014 (MYR) 2,687,653,401.53

Number of shares 371,226,025.00

Share Price (MYR) 7.24

Share Price (in SGD)** 2.82

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We have done 2 scenarios, in one of them we increase the long term growth rate by 1% and in

second case, we increase the market return by 1%. The detailed Calculations are shown in

Appendix VII.

Scenario 1:- Using the FCFF method, our current share price is $2.82. If we increase the long term

growth rate of the free cash flows by 1% to 3.46% keeping all the other variables constant, the

share price increases by 91% to $5.39. This implies a high sensitivity of the share price to the long

term growth rate. However, this is understood as 1% increase in long term growth rate is very

significant as it impacts the cash flows till infinity.

Scenario 2:- If we increase the market return by 1%, keeping all other variables constant, the

required return on stock increases to 4.70334% from the current 4.5179%. Thus, the WACC, which

is the same as required return on stock in Riverstone’s case, increases. This leads to the share

price falling to $2.58 by 8.5%.

Therefore, we do realize the limitations in our computations as the assumptions used in the FCFF

method and to calculate the WACC affect the share price of the Company and there is no right

answer for the share price. However, given our assumptions, we believe the share price of the

Company to be at $2.82.