Draft Valuation Report

of the Fair Market Value of a

100% Equity Interest inNaftna

industrija Srbije A.D., Novi Sad

as of 30 June 2008

(draft summary report)

Deloitte d.o.o. Makenzijeva 24 11000 Beograd Srbija Tel: +381 11 3812 100; +381 11 3821 200 Fax: +381 11 3812 101;

+381 11 3821 202 www.deloitte.com/serbia

Agencija za privatizaciju Terazije 23 Belgrade, Serbia

Belgrade, 1 September 2008

Dear Madam/Sir,

Pursuant to the contract for providing valuation services between Deloitte d.o.o. and Privatization Agency dated 04 August 2008 we have conducted the valuation of the fair market value of a 100% equity interest of Naftna industrija Srbije A.D., Novi Sad, Serbia (further referred to as “NIS”, or the “Company”).

We conducted the valuation of 100% interest in equity of NIS on a control non-marketable basis as of 30 June 2008. The purpose of our valuation consulting services was to assist the Privatization Agency in determining the value of equity of NIS in order to calculate the percentage of equity interest that would be transferred to the current and former employees of NIS in accordance with Article 23 of Law on Free Shares and Monetary Remuneration that citizens realize in the process of privatization. It is our understanding that we are required to provide a written report expressing and supporting our opinion of the fair market value of equity of Naftna industrija Srbije a.d., Novi Sad on a control non-marketable basis as of 30 June 2008. This report is not intended to be used for any other purpose or distribution to third parties without the express knowledge and written consent of Deloitte.

For the purpose of this draft summary report, we used American Society of Appraisers’ definition of the Fair Market Value: “The estimated amount at which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion”.

The Valuation Report sets out the limiting conditions and pertinent facts available to us in arriving to our conclusions.

Our valuation analysis is based on the premise that the Company is and will continue as a going-concern business enterprise. This premise implicitly assumes that (1) the management will implement only those prospective financial and operational strategies that will maximize the efficiency of the business entity, and (2) that there are no factors (such as continued operating losses and financial weakness) that call into question the fundamental assumption that the entity can and will continue to operate as a going-concern.

On the basis of our research, study, inspection, investigation, and analysis as set forth in the attached valuation report, we are of the opinion that the fair market value of 100% of equity of Naftna industrija Srbija a.d., Novi Sad, on a control non-marketable basis, as of 30 June 2008 is (rounded):

2,200,000,000 EUR

(two billion and two hundredmillion Euros )

The result of our valuation consulting services does not constitute a fairness opinion or investment advice and should not be interpreted as such. Our conclusions do not serve as a substitute for the due diligence process, and any third party should perform their own due diligence in order to structure any possible transaction with the Company. Accordingly, this report is not intended to supplant other inquiries and procedures that any third party should undertake for considering a transaction with the Company.

During this consulting analysis, we were provided by NIS with both audited and unaudited financial, operational, and forecast data. In addition to information provided by NIS, we used various publicly available data. We have relied on this data without independent verification or confirmation. As a part of this consulting analysis, we have not audited this data. Accordingly, we issue no opinion or other form of assurance regarding this data. We did not have opportunity to provide the management of NIS with a draft valuation report. Had we been able to discuss the results of our valuation analysis with the management of NIS and had we received their comments thereon we might have found that some changes to this report would be needed, and these changes might be material.

It should be understood that the actual price paid in a transaction involving equity interest in NIS might differ from an estimated range of fair market values. The differences between price paid and estimated value may be due to factors such as the motivation of the parties, the

Table of Contents

1 INTRODUCITION..........................................................................................................1

1.1 LIMITING CONDITIONS................................................................................................1 1.2 HYPOTHETICAL ASSUMPTIONS MADE.........................................................................3 1.3 APPRAISAL PROCEDURES............................................................................................4 1.4 SOURCES OF INFORMATION.........................................................................................5

2 MACROECONOMIC OVERVIEW .............................................................................7

2.1 GENERAL DESCRIPTION OF THE COUNTRY..................................................................7 2.2 KEY MACROECONOMIC INDICATORS..........................................................................9 2.3 GROSS DOMESTIC PRODUCT.....................................................................................10 2.4 INFLATION, EXCHANGE RATES AND INTEREST RATES ..............................................11

2.4.1 Inflation Rate .......................................................................................................11

2.4.2 Exchange Rate .....................................................................................................11

2.5 FOREIGN EXCHANGE TRADE.....................................................................................12 2.6 EXTERNAL DEBT.......................................................................................................13 2.7 FOREIGN DIRECT INVESTMENT .................................................................................14 2.8 UNEMPLOYMENT ......................................................................................................16

3 PETROLEUM INDUSTRY IN THE WORLD ..........................................................16

3.1 RESEARCH AND PRODUCTION (UPSTREAM) ...............................................................17 3.2 REFINING AND PROCESSING (MIDSTREAM) ................................................................17 3.3 DISTRIBUTION OF OIL AND OIL DERIVATIVES (DOWNSTREAM) ..................................18 3.4 GLOBAL MARKET ......................................................................................................19

3.4.1 Demand................................................................................................................19

3.4.2 Oil market supply.................................................................................................19

3.4.3 Crude oil prices....................................................................................................20

3.5 PETROLEUM INDUSTRY IN THE REPUBLIC OF SERBIA ................................................21 3.5.1 Primary energy system – production and import of crude oil .............................22

3.5.2 Primary energy transformation system – refining of crude oil............................22

3.5.3 Final consumption and distribution of oil industry products ..............................23

3.5.4 Oil derivatives prices regulation .........................................................................25

4 VALUATION APPROACHES AND METHODOLOGY............... ..........................26

4.1 DISCOUNTED CASH FLOW (DCF) .............................................................................27 4.2 MARKET APPROACH.................................................................................................29 4.3 ASSET ACCUMULATION (COST) APPROACH..............................................................30 4.4 SUMMARY - BUSINESS VALUATION METHODS.........................................................31

5 THE COST APPROACH - THE NET ASSETS VALUE METHOD .... ..................32

5.1 RECLASSIFICATIONS TO THE REPORTED BALANCE SHEET AS OF 30 JUNE 2008..........33 5.1.1 Property, plant and equipment ............................................................................34

5.1.2 Long-term financial placements ..........................................................................34

5.1.3 Current assets ......................................................................................................34

5.1.4 Long-term and short-term liabilities....................................................................35

5.2 ADJUSTMENTS TO THE RECLASSIFIED BALANCE SHEET AS OF 30 JUNE 2008 .............35 5.3 INTANGIBLE ASSETS..................................................................................................35

5.3.1 Introduction..........................................................................................................35

5.3.2 Trained and assembled workforce.......................................................................36

5.3.3 Research, exploration and extraction of crude oil and natural gas in Serbia

concession rights..............................................................................................................40

5.3.4 Other Intangible Assets........................................................................................47

5.3.5 Intangible Assets Value Conclusion.....................................................................47

5.4 PROPERTY, PLANTS AND EQUIPMENT........................................................................48 5.5 LONG-TERM FINANCIAL PLACEMENT ........................................................................49 5.6 INVENTORIES............................................................................................................49 5.7 RECEIVABLES, FINANCIAL PLACEMENTS AND CASH AND DEFERRED TAX ASSETS......51 5.8 LONG-TERM LIABILITIES AND PROVISIONS................................................................52 5.9 SHORT-TERM LIABILITIES ..........................................................................................52 5.10 NAV – CONCLUSION OF VALUE................................................................................53

6 DISCOUNTED CASH FLOW VALUATION METHOD.............. ...........................56

6.1 INTRODUCTION.........................................................................................................56 6.2 FORECAST ASSUMPTIONS..........................................................................................57

6.2.1 Extraction of crude oil and natural gas...............................................................57

6.2.2 Refining production and structure .......................................................................58

6.2.3 Import of crude oil ...............................................................................................61

6.2.4 Sales forecast .......................................................................................................63

6.2.5 Export / import of oil derivatives .........................................................................64

6.2.6 Price of crude oil .................................................................................................65

6.2.7 Price of oil derivatives .........................................................................................70

6.2.8 Macroeconomic and other assumptions ..............................................................73 6.3 PROJECTION OF REVENUES........................................................................................74

6.3.1 Sale on domestic market (retail and wholesale) ..................................................74

6.3.2 Revenue from export ............................................................................................75

6.3.3 Revenue from oil refining services.......................................................................76

6.3.4 Revenue from sales of oil from Angola................................................................77

6.3.5 Revenue from sales of gas....................................................................................77

6.3.6 Other revenue.......................................................................................................78

6.3.7 Summary of total revenue ....................................................................................79

6.4 PROJECTION OF COSTS...............................................................................................79 6.4.1 Cost of crude oil imports......................................................................................79

6.4.2 Cost of oil derivatives import...............................................................................80

6.4.3 Cost of own oil and gas production .....................................................................80

6.4.4 Refining costs .......................................................................................................82

6.4.5 Selling costs .........................................................................................................84

6.4.6 Projection of total operating costs.......................................................................85

6.5 INCOME STATEMENT PROJECTION.............................................................................86 6.6 PROJECTION OF CAPITAL INVESTMENTS....................................................................89 6.7 WORKING CAPITAL PROJECTION...............................................................................90 6.8 NON-OPERATING ASSETS.........................................................................................91 6.9 CASH FLOW PROJECTION AND DCF SUMMARY – SCENARIO 1..................................92 6.10 CASH FLOW PROJECTION AND DCF SUMMARY – SCENARIO 2..................................94 6.11 DCF VALUE CONCLUSION.........................................................................................96 6.12 DISCOUNT RATE CALCULATION.................................................................................97

7 MARKET APPROACH................................................................................................98

7.1 THE MARKET APPROACH APPLICATION....................................................................99 7.2 THE GPC METHOD APPLICATION.............................................................................99

7.2.1 Criteria for selecting the comparable guideline companies..............................102

7.2.2 Selected guideline companies ............................................................................102

7.2.3 Selection and application of multiplies..............................................................106

7.2.4 Country and size risk adjustments .....................................................................107

7.2.5 Control premium adjustments............................................................................107

7.2.6 Cross ownership adjustments ............................................................................108

7.2.7 Application of the valuation multiple.................................................................108

7.2.8 Interest bearing debt and non-operating assets adjustment ..............................109

7.2.9 Notes on premiums and discounts......................................................................109

7.2.10 GLC - Valuation Conclusion .........................................................................109

7.3 THE MERGERS AND ACQUISITIONS (M&A) METHOD APPLICATION.......................114 7.3.1 Criteria for selecting comparable transactions.................................................114

7.3.2 Selection and application of multiplies..............................................................115

7.3.3 Country and size risk adjustments .....................................................................115

7.3.4 Control premium adjustments............................................................................115

7.3.5 Application of the valuation multiple.................................................................116

7.3.6 Interest bearing debt and non-operating assets.................................................116

7.3.7 The M&A Method - Valuation Conclusion ........................................................116

8 VALUE CONCLUSION .............................................................................................118

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1 Introducition

The objective of our valuation was to estimate the fair market value of a 100% equity of NIS on a control non-marketable basis as of 30 June 2008. The purpose of our valuation consulting services was to assist the Privatization Agency to determine the value of equity of NIS in order to establish the percentage of equity interest that would be transferred to the current and former employees in accordance with article 23 of Law on Free Shares and Monetary Remuneration that citizens realize in the process of privatization. It is our understanding that we are required to provide a written report expressing and supporting our opinion of the fair market value of equity of NIS on control non-marketable basis as of 30 June 2008. Accordingly, no other purpose is intended or should be inferred. Furthermore, our valuation analysis does not represent a fairness opinion or investment advice and should not be interpreted as such.

1.1 Limiting Conditions

For purposes of this engagement, we define fair market value, as “the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and when both have reasonable knowledge of the relevant facts.” The conclusion of fair market value reached is therefore a reasonable estimate of the price at which property may change hands between two willing parties. It should be understood that the actual price paid in a transaction involving enterprises of NIS may differ from the appraised fair market value due to factors such as the motivation of the parties, the negotiation skills of the parties, the structure of the transaction (e.g. financing structure, transition of control, etc.), or other factors unique to the transaction.

It should be however stressed that the term „fair market value” represents the intrinsic value of a company valued. Intrinsic value is defined for our purposes as a notional value which we believe would prevail based upon rates of return required by investors given economic and business conditions existing at the valuation date, without consideration of possible synergistic (or economies of scale) benefits that might accrue in differing degrees to arm’s length corporate purchasers.

With respect to the fair market value of NIS , we further comment as follows:

• we believe that there are, in essence, as many ‘prices’ for any business interest as there are purchasers and that each purchaser for a particular ‘pool of assets’, be it represented by overlying shares or the assets themselves, can likely pay a price unique to it because of its ability to utilize the assets in a manner peculiar to it. In any open market transaction, a purchaser will review a potential

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acquisition in relation to what economies of scale (e.g. reduced or eliminated competition, ensured source of material supply or sales, cost savings arising on business combinations following acquisitions, and so on), or ‘synergies’ that may result from such an acquisition. Theoretically, each corporate purchaser can be presumed to be able to enjoy such economies of scale in differing degrees and therefore pay a different price for a particular pool of assets;

• in situations where no specific third party purchaser has been clearly identified, we believe that it is extremely difficult, if not impossible, to comment on the price that will be paid in an open market transaction with any degree of certainty. Where a specific arm’s length third party purchaser has not been clearly identified, we generally base our opinion as to the fair market value of a pool of business assets on the earnings and cash flows in relation to the net tangible assets backing. Our principal reason for adopting this approach is founded in our belief that unless a pool of business assets is exposed for sale, it is often speculative as to whether or not purchasers do exist who:

i. can take advantage of economies of scale, or synergies, and

ii. even if they can realize economies of scale, can be negotiated into a position to pay for them.

Further, we believe that it is only in negotiation with a purchaser that such economies of scale can be quantified and with respect to that,, the purchaser is generally in a far better position to quantify the value to it of the economies of scale than is the vendor;

Although our value calculations attempt to reflect the underlying asset values, and what we perceive to be the long term income and discretionary cash flow potential of NIS, it is important that the shareholders clearly understand that an arm’s length, third party purchaser may have been, and may be willing to pay a price for the shares other than that noted herein. We re-emphasize that it is our view that only when a business interest is exposed for sale that the impact on ‘price’ of arm’s length, third party purchaser synergies can be quantified with any degree of certainty, and at that, such quantification is usually more meaningful for the purchaser than it is for the vendor.

We have based the valuation on publicly available information and on the information and data provided by the Company, which we consider accurate and reflective of the historical financial position and operations situation of the Company. With respect to the financial projections, including information relating to certain strategic, financial and operational benefits forecasted by NIS, we have assumed that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the future financial performance of the Company as of 30 June 2008.

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Our conclusion depends on such information being complete and accurate in all material respects. However, the scope of our work does not enable us to accept responsibility for the accuracy and completeness of such provided information.

The valuation was prepared on the basis of the conditions that were known at the time it was prepared; we do not assume the responsibility for potential changes in market conditions after the delivery of the valuation report and consequent updates of the valuation report for potential changes of the market conditions or otherwise.

The Company provided us with adjusted sales and production mix plans and forecasts. It is our understanding that production mix forecasted by the management of NIS has not been subject to detailed analysis but rather the best estimate based on the limited time and information available. Given the limited time to prepare the valuation, the management of NIS was unable to prepare the updated financial forecast that would fully reflect the cost effects of the assumed product mix. Such product mix projections and calculations of refining margins in particular are typically performed by a sophisticated refinery production planning software which is usually company specific. We would like to underline that the forecast which assumes optimal product mix and the associated costs and margins would most likely differ to the forecast used in this valuations and the results of potential adjustments might be material.

As part of the valuation we did not perform audit procedures and, accordingly, we issue no audit opinion or other form of assurance of this data. The results of the valuation, calculations, conclusions and detailed calculations are presented in the appendices to this report.

The results of the valuation are valid only in relation to the defined purpose and period.

1.2 Hypothetical Assumptions Made

Our valuation was subject to numerous hypothetical conditions and assumptions whose changes might materially affect our valuation conclusion. The hypothetical assumptions used were either provided by management of NIS or collected from publicly available information.

The major hypothetical conditions and assumptions used are as follows:

1. The concession rights for research, exploration and production of oil and natural gas are irrevocable and not time limited.

2. The royalty rate will remain at current level of 3% of revenue earned.

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3. The current legal framework granting NIS monopolistic position by forbidding the import of petroleum derivatives, apart from Euro Diesel, will remain in force until 2012 or by the time when it is expected that NIS refineries will be able, after undergone CAPEX, to produce petroleum derivatives in accordance with EU standards. It is also further assumed that once NIS starts own production of Euro Diesel, its unit production cost will be at the level which will allow the Company to sell this fuel at prices lower than those of competition.

4. The current pricing mechanism in use in Serbia that pegs the price of the most of the petroleum derivatives to the spot price of crude oil will remain in power during our projection period.

5. CAPEX estimated by NIS is adequate for bringing the refining capacities up to date with EU standards and the capital expenditure program will be implemented as per strategic plan;

6. We assumed the future crude oil prices by reference to publicly available data from credible sources (Energy Information Agency, the Economist Intelligence Unit, Deutsche Bank, NYMEX, etc). We draw your attention that this type of the forecasted data rarely matches actual prices in the long run. Any change to the assumed oil prices may have significant impact to the results of our valuation.

7. In our projections we assumed that all surplus production that cannot be sold in the Serbian market will be exported.

8. We fully relied on the forecasted production and sales quantities as provided by NIS.

1.3 Appraisal Procedures

In carrying out this valuation study, our investigation and analysis included, but was not limited to the following activities.

We received information regarding the financial and operational performance of NIS in the first half 2008, 2007, and 2006, and revised strategic plan of NIS for the period 2008-2010. After analyzing the received information, we requested certain explanations and additional data to enable us to better understand the financial position of NIS as of 30 June 2008 and forecasted operations information.

We reviewed and made adjustments to the financial statements of NIS as of 30 June 2008 in order to bring them in compliance to IFRS and normalize them for extraordinary items. Normalization and IFRS adjustments were needed to evaluate the

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true profitability of the Company in accordance with IFRS, and for better comparability to other relevant oil and gas companies and to enable us to forecast future expected cash flows.

We performed the appraisal of major property, plant and equipment and investment properties. Third party, appraisers conducted the appraisal by application of the Comparable Sales Method for valuation of investment property and the Depreciated Replacement Cost Method for appraisal of Property, Plant and Equipment as of 30 June 2008.

Per our request, NIS provided us with estimates of fixed and variable costs related to production of oil, refining operations and marketing operations. We relied on this data as provided by NIS without further investigations.

For the purpose of applying the Market Approach to valuation we collected data on comparable companies and transactions. The sources of our research were the financial databases we have access to such as Bloomberg, OneSource, Factiva and etc. We used the data provided by these databases without further investigations to accuracy thereof. After collecting the market data on comparable companies and transactions we used this data, after proper adjustments, in application of the Market Approach to valuation.

For the purpose of application of Net Assets Value Method we identified and valued intangible assets not reported in the financial statements of NIS. The intangible assets we separately identified and valued include Assembled Workforce and Concessions Rights related to research, exploration and production of oil and natural gas in Serbia.

After we collected and reviewed the data received from the Company and our own sources, we analyzed all available information to select the most appropriate methods of valuation for this assignment. We derived the range of values conclusion by utilizing the Discounted Cash Flow (DCF) method, the Net Assets Value Method (NAV), the Guideline Public Companies Method (GPC), and the Mergers and Acquisitions Method (M&A).

1.4 Sources of Information

As part of the valuation, efforts were undertaken to ensure cooperation in the provision of reference documents. The obtained information and required documentation were used for the preparation of the valuation, specifically the following material:

� Audited financial statements of the Company for the years ended December 31, 2007, 2006 and 2005;

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� Unaudited financial statements of the Company for the period from 01 January 2008 to 30 June 2008 and 01 January 2007 to 30 June 2007;

� Annual reports of the Company for the years ended 31 December 2007, 2006 and 2005;

� Auditor’s reports for the years ended 31 December 2007 and 2006;

� The Company’s Strategic Plan up to 2010 dated June 2008;

� Planned CAPEX for the period 2008-2012;

� Adjusted forecasted sales per products/services for the period 2008-2010;

� Adjusted cracking margin for refineries Pancevo and Novi Sad for the period 2008-2010;

� The Company’s Articles of Association;

� The list of property, plant and equipment as of 30 June 2008;

� The list of non-current financial assets;

� Breakdown of long-term receivables;

� The list of principal customers;

� Breakdown of intercompany receivables and payables;

� The list of created reserves and the specification of the purpose of their creation and plan of release;

� The list of principal suppliers;

� Breakdown of long-term payables;

� Breakdown of bank loans;

� Specification of accruals and deferrals;

� The list of lease contracts;

� Description of off-balance assets and liabilities;

� Breakdown of principal items of other operating income and expenses;

� Breakdown of principal items of other financial income and expenses;

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� Description of the principal products/services of the Company with the specification of their share in total sales for the first half of 2008, 2007, 2006 and 2005;

� Description of the standing of individual products/services of the Company on the market and their comparison to competitive products;

� The list of companies active in the same sector as the Company and an estimate of their share in the market and comparison to the Company;

� Description of the possibilities for the entry of new competitors to the market;

Other data used in this Valuation, unless stated otherwise, comes from the following sources:

� Bloomberg Professional database;

� Bureau van Dijk’s Amadeus;

� Onesource Business Browsers;

� ISI Emerging Markets;

� Mergerstat;

� Thomson Research;

� Standard & Poor‘s Industry Surveys;

� The Economist Intelligence Unit (EIU);

� Energy Information Agency;

� Deutsche Bank Analyst Reports;

� Articles and studies from valuation conferences concerning premiums for controlling interest and discounts for lower marketability of the Company; and

� Publicly available information

2 Macroeconomic overview

2.1 General Description of the Country

Serbia is located in South-eastern Europe in the central part of the Balkan Peninsula and the southern part of the Pannonian Plain. It is bordered by Macedonia, Albania and Montenegro to the south, Bosnia and Herzegovina and Croatia to the west, Hungary to the north, Romania and Bulgaria to the east. The Republic of Serbia

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covers 88,361 square km. The Danube, an important traffic river for Europe, flows through the territory of the country.

Serbia is in Central European time zone (GMT +1). According to the figures from the most recent census in 2002, conducted only for the territory of Serbia excluding Kosovo and Montenegro, the population is 7,479,437. In terms of demographics, total population is approximately comprised of 47.5% males and 52.5% females. According to census from 2002, the majority of inhabitants are between 15 and 60 years of age, i.e. approximately 4.6 million. The overall population growth rate in July 2004 was estimated at 0.03%. Currently, the life expectancy at birth is 71 years for men and 77 years for women. About 93% of the overall population is considered to be literate. Official and most used language is Serbian. Considering minority in some regions, Albanian is spoken in Kosovo and Hungarian in Vojvodina.

The main cities of Serbia include capital Belgrade, with a population of 1.602 million in 2003, followed by Novi Sad (299 thousand), Niš (251 thousand) Kragujevac (176 thousand), and Priština.

Figure1-1 Map of Serbia

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The Serbian climate is mostly continental. Average temperature in July is from 17 to 28 C and the coldest month is January with average temperature -30C. Cultivated land is about 40% of Serbian territory, pastures 20.7% and forests 17.3%. Remained 22% of territories are mountains, lakes and other geographic entities.

2.2 Key Macroeconomic Indicators

In the period from 1990 to 1993, the GDP declined by 56%. Starting in 1994, there was a gradual recovery of the domestic economy, when a 5.5% growth in GDP was recorded. Due to an expansionary monetary policy, in 1997 GDP growth peaked at 7.4%, however, the following year was characterized by a slowdown of the economy. This slowdown continued in 1999 as a result of the NATO bombing, leading to a drastic increase in the inflation rate.

The Serbian economy started to recover once again after 2000. A continuous growth of GDP level is recorded from 2000 onwards (an average of some 6.5%), a trend that is expected to continue going forward. Generally, all major trends are favorable, as the economy is rebounding after the slump in the nineties.

The trend of high economic growth, lower inflation rate, export increase, FDI flow, high foreign trade surplus, improving efficiency, high unemployment and salary increase above productivity has continued in 2007.

Macroeconomic trend in Serbia in 2007 has been accompanied with real GDP growth by 7.5% and reduction of inflation rate to the level of 10.1%. Beside that, there has been significant increase of export of 37.5% (in EUR) and increase of National Bank of Serbia FX reserves up to EUR 10.9 billion. The trend of economic growth has continued in 2007. Estimated GDP growth for 2008 is 6.5% and retail price index is estimated to be 9.5%.

Key macroeconomic indicators from 2003 –2007. along with projections for 2007 are shown in the table below:

Table 2-1-1 Key Macroeconomic Indicators 2003–2007

2003 2004 2005 2006 2007 2008

GDP, prices, billion RSD 1,171.6 1,431.3 1,750.01 2,125.82 2,435.4 2,878.9

GDP, million EUR 18,010.8 19,723.0 21,104.8 25,2622 30,451.73 35,986.2

GDP, per capita,ЕUR3 2,401.4 2,629.7 2,814.0 3,3542 4,131.4 4,852.5

Real GDP growth (%) 2.5 8.4 6.21 5.71 7.5 6.5

Price, growth rate

Retail price index (%) 7.8 13.7 17.7 6.6 10.1 9.5

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Living expenses 9.9 11.4 16.2 11.7 7.0 14.77

Foreign exchange trade ЕUR4,5

Export 2,441.0 2,831.6 3,608.3 5,102.5 6,432.2 3,647.97

Export in EU 1,202.3 1,456.5 2,117.6 2,942.9 3,602.7 2,004.47

Import 6,585.5 8,623.3 8,439.2 10,462.6 13,506.8 7,784.57

Capital goods import6 1,779.4 2,495.3 1,971.6 2,429.8 3,495.9 1,991.67

Intermediary good import6 2,251.9 2,830.6 3,027.6 3,781.4 4,892.1 2,685.57

Exchange deficit -4,144.3 -5,791.7 -4,831.0 -5,360.1 -7,074.5 -4,136.67

Foreign direct investment, net, EUR million 1,208.6 777.7 1,244.6 3,398.7 1,601.6 984.37

Unemployment, official rate (%) - 19.5 21.8 21.6 18.8 -

Source: Serbian Ministry of Finance, Economist Intelligence Unit

*Estimate Statistic Bureau. 1 Previous results 2 Estimate Ministry of Finance 3. According to average

year FX RSD/EUR 4.Foreign exchange trade in 2006 included and Montenegro 5. For converting USD

to EUR for y 2001 and 2002, used average FX for that year. Same for balance payment from 2001 to

2007 6. New classification is being implemented since 2004 7. Data for the first 6 months, 2008

2.3 Gross Domestic Product

Serbian gross domestic product has been constantly growing in the period 2000 – 2007. The trend of high economic growth is driven principally by domestic and foreign aggregate demand, successful privatization and inflow of foreign direct investments.

The most dynamic growth in 2007 is realized in services sector (totally 11.4%), whereas the industry registered the growth of 3.6%. In 2007, agriculture activity fell by 8%. In the upcoming period a high growth, especially in the services sector as the main generator of GDP growth, is expected.

As a consequence of continuous growth, GDP per capita in 2007 reached more than EUR 4,000.

Overview of GDP growth in the period 2008-2012 is given in the following table:

Table 2-1 GDP rate projections in the period 2008-2012:

Year 2008 2009 2010 2011 2012

Growth % 6.5% 6.3% 5.3% 5.0% 4.7%

Source: Economist Intelligence Unit

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2.4 Inflation, Exchange Rates and Interest Rates

2.4.1 Inflation Rate

The inflation trend of recent years has been reversed in 2004, owing to rapid wage growth, higher than expected international oil prices, and faster nominal exchange-rate depreciation. Year-on-year retail price inflation in Serbia in 2004 reached 13.8% at year end.

Introduction of VAT at the start of 2005 gave another upward push to inflation, which coupled with high oil prices pushed inflation to 17.7% at year end. Inflation rate in 2006 was 6.6% while in 2007 retail price index was 10.1%.

In the following period deflationary policy is planned to continue by means of restrictive monetary and fiscal policy, respectively reducing it to one digit number. Overview of projected retail inflation rates in the period 2008-2012 is given in the following table:

Table 2-2 Projected retail index in the period 2008 - 2012:

Year 2008 2009 2010 2011 2012

Growth % 9.5% 6.5% 4.6% 4.0% 3.6%

Source: Economist Intelligence Unit

2.4.2 Exchange Rate

Following the period of hyperinflation in the 1990s, various programs aimed at stabilizing foreign exchange rates and reducing inflation by implementing a range of monetary policy measures were initiated. As from January 01, 2001 Serbian currency (RSD) becomes convertible money.

RSD and USD ratio along with RSD and EUR ratio for the period 2001 – 30 June 2008 is given in the table below:

Table 2-3 Exchange rates in the period 2001.- June 30th 2008.

Year RSD / USD RSD / EUR Average Year end Average Year end

2001 66.68 67.67 59.77 59.71 2002 64.49 58.98 60.68 61.52 2003 57.58 54.64 65.07 68.31 2004 58.39 57.94 72.58 78.89 2005 66.72 72.22 82.91 85.50 2006 67.10 59.98 84.16 79.00

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Year RSD / USD RSD / EUR Average Year end Average Year end

2007 53.73 58.44 79.99 79.24 2008 52.87 50.01 78.98 81.33

Source: Serbian Ministry of Finance, National bank of Serbia

2.5 Foreign Exchange Trade

Foreign exchange trade increase in 2007 was mainly due to a significant export growth, causing it to be one of main generators of economic growth. Despite that, velocity of export growth is not sufficient comparing to export growth, which shows an increased deficit in foreign exchange trade to total of EUR 7.07 billion. On the import growth a significant impact had the effects of privatization and economy restructuring, especially industry sector. Moreover the growth was boosted by all components of domestic aggregate demand (reproduction, high energy-generating products price increase in 2007, investment and consumption demand).

Price increase of metal products affected both import and export growth.

According to Statistics Bureau, foreign trade deficit raised in 2007 by EUR 1.7 billion, although import has increased for 26%. There has also been increase in current account for 23.2% of GDP which points at huge unbalanced foreign trade. Deficit of foreign trade has been financed through FDI flow in amount of EUR 1.6 billion. Since the FDI flow came from privatization, not from Greenfield investments, this kind of deficit financing is not sustainable for mid term. Increasing of foreign trade deficit is consequence of raise in domestic demand which increased in 2007 due to raise of salaries and consumption. Significant RSD appreciation additionally contributed to raising the deficit.

Main export markets for Serbian products in 2007 were Italy, Bosnia and Herzegovina, German and Montenegro. Overview of export markets is given in figure below:

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Figure 2-2 Main export markets in 2007

Source: SIEPA

The largest exporters to Serbia were Russia (over USD 2.6 billion), Germany (USD 2.1 billion), and Italy (USD 1.7 billion).

Figure 2-3 Main import countries in 2007

Source: SIEPA

2.6 External Debt

Public debt on 30 June 2008. compared to 2000 decreased through pay-offs and write-offs of public debt. At the end of 30 June 2008, public debt was EUR 7764 million, from which EUR 4515.8 million comes from external debt and the rest in amount of EUR 3249 million is internal debt.

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Public debt decreased in 2008 compared to the end of 2007 by EUR 264.3 million. Public debt participation in GDP, through write-offs and responsible fiscal policy, has been decreased and by the middle of 2008 amounted to 25.3%. Figure below shows public debt on 30 June 2008, as well as at the end of 2006 and 2007.

Figure 2-4 External and public debt in EUR million

Source: Serbian Ministry of Finance

2.7 Foreign Direct Investment

The privatization has been the key source of Foreign Direct Investment in the period 2000 – 2007. From the year 2000, FDI in Serbia has been constantly growing, except for the near halt in the first half of 2004. However, the privatization was well underway since, with focus on banking sector and privatization through restructuring of state and socially owned companies.

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Figure 2-5 Foreign Direct Investment in the period 2002 - 2007

Source: National bank of Serbia

In the following period a stable inflow and growth of foreign direct investments is expected due to further liberalization of business framework in Serbia, infrastructure investments, and favorable foreign exchange agreements with neighbor countries (CEFTA), Russia and EU.

Between 2001-2007 a predominant percentage of direct investments was from EU countries. In the following figure, a structure of foreign direct investments by countries of origin is shown.

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Figure 2-6 Foreign Direct Investments by country of origin in the period 2002-2007.

Source: National bank of Serbia

2.8 Unemployment

According to the Economic Review of National Bank of Serbia, the unemployment rate in September 2007 was 24.4%, which represented an increase of 0.7% compared to March 2006. This rate was calculated on the basis of the number of employees, including individual farmers who have not been covered by the sample so far. According to those data, total number of employees in September 2007 was 2.5 million and the number of unemployed was 882 thousand.

3 Petroleum Industry in the World

Petroleum industry traditionally represents one of the largest branches of the world economy, due to its natural resource that is a subject of processing and distribution. From its discovery, oil has been one of the cheapest energy alternatives and the most available source of carbon-oxide for all kind of processes in the chemical industry. Having in mind the above mentioned, it was almost impossible to imagine functioning of world economy without the petroleum industry in the short and mid-run.

Currently, global energy consumption structure is dominated by consumption of oil which comprises 35% of all primary energy resources, followed by coal as a second important energy resource with 28% of share in total energy consumption and natural gas which covers 24% of global energy demand. Current short-term and mid-term studies about energy consumption do not assume any changes regarding share of oil and natural gas in total energy resources.

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Proven world reserves of crude oil in 2006 totaled to approximately 1,205 billion barrels, which is slightly more compared to the previous year. Increases of crude oil reserve mostly resulted from new assessments of existing oil fields since discovering of new oil fields is relatively slowly.

Reserves of natural gas in 2006 totaled to 181.46 trillion cubic meters and this is an increase of 33.56% in comparison to 1996. Currently, annual production of natural gas is around 377 billion cubic meters which allows 63.3 years of exploitation.

When we look at the structure of petroleum industry in the world, we can identify three main industry segments: 1) research and production (upstream), 2) refining and processing (midstream) and 3) distribution of oil and oil derivatives to the final consumers (downstream).

3.1 Research and production (upstream)

The global industry of oil and gas research and production today consists of around 7,000 companies, with compound revenue of over USD 3 trillions. Industry shows a moderate level of concentration, where 10% of largest companies generate 60% of revenue. This segment of petroleum industry includes research and production of oil and natural gas up to the moment when oil is sent to refineries and distributed to the final consumers.

Major companies with upstream capacities in the region of Central and South-East Europe (CEE/SEE) are Austrian OMV, Hungarian MOL, ENI, EDISON, Romanian PETROM, INA, Croatia and Naftna industrija Srbije.

3.2 Refining and processing (midstream)

The global oil and gas refining and processing industry (including transport as a significant segment) today consists of more than 10,000 companies. Industry is regionally segmented with few multinational companies that represent one of the largest companies in the world (EXXON Mobile, Texaco, British Petroleum, Royal Dutch Shell etc.)

When we look at the Central and South-east Europe region, most of the countries rely on the oil imports for satisfying their needs. Due to its geographical location and the fact that most of them have no access to open sea, the main way to transport and supply the region with crude oil from Russia is Druzbha pipeline. Exceptions are refineries in Romania that have an access to the open sea through port of Constant and refinery in Croatia, Rijeka that is situated on the Adriatic coast.

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Company with the largest capacities for refining and processing of crude oil in the region is Polish oil&gas company PKN Orlen, which is primarily oriented on the markets of Poland, Czech Republic and Baltic countries. It is followed by Austrian OMV, oriented on markets of Austria, Romania and Germany.

Naftna industrija Srbije and Croatian national oil and gas company INA, are among smaller oil&gas companies in the region.

Figure 3-1 Location of refineries in Central and Sout Eastern Europe

Source: OneSource internet portal

3.3 Distribution of oil and oil derivatives (downstream)

Distribution of oil and oil derivatives refer to sales of products through wholesale installation and to retail network – petrol stations. Retail networks are usually owned by oil companies or could be managed by other entities which are in franchising relationship with one of the oil companies.

The largest retail network in Central Europe is owned and managed by PKN Group, Poland and consists of 2,764 petrol stations. Second largest gas stations network is OMV’s network with 2,538 stations and third is Hungarian MOL’s retail network with 992 stations. Romanian Petrom has the largest retail network in South Eastern Europe with 450 petrol stations. Naftna Industrija Srbije operates with 486 stations and Croatian INA has retail network of 414 gas stations.

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3.4 Global market

3.4.1 Demand

Global demand for crude oil in 2007 reached 86 million barrels per day which is 2.72% more compared to 83.72 million barrels per day which was crude oil demand in 2006. According to Economist Intelligence Unit research, global demand for crude oil could reach 86.9 million barrels per day by the end of 2008 with steady growth in 2009. By the period 2010-2012, crude oil demand is forecasted to grow at average rate of 2.1% annually, but with more rapid growth in OECD countries (expected annual growth of 4.4%).

USA is the largest oil consumer in the world with share of around 26% in total global consumption. EU countries’ share in total oil consumption is 18%, China has share of 6% and together with USA consumption that makes more than a half of global oil consumption. Analysis of oil consumption per continents results in similar conclusion – America dominates global oil consumption with 35%, followed by Asia and Pacific with 30% and Europe with over 20% of total oil consumption.

Figure 3-2 Crude oil consumption per country in 2007

3.4.2 Oil market supply

Total supply of crude oil in 2007 amounted to average 85.51 million barrel per day, which is an increase of 0.12% compared to 2006. The Economist Intelligence Unit forecasts that the global supply of crude oil in the world will reach 87.83 million barrel per day with further stable growth to 91.94 million barrels per day in 2010.

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OPEC countries dominates total crude oil supply with 38% (or around 32.4 million barrels per day), followed by Russia and North America.

Figure 3-3 Crude oil offer per country in 2007

3.4.3 Crude oil prices

Crude oil prices in global market currently record a slight decrease compared to historical peak of USD 147 per barrel (11 July 2008). Rapid prices growth which began in second half of 2007 and resulted in all time price record in July 2008, was resulted by uncertainty and panic regarding stable procurement with crude oil in long and short period of time. The reason for the panic was constant geopolitical tension in the regions which are main crude oil suppliers (short term uncertainty), slow increase in production in the countries outside the OPEC and the assessment of International Energy Association (IEA) that the demand would grow at 2.4% in 2008 (long term uncertainty). Additional pressure on price increase was caused by speculative investors which used crude oil as a hedging instrument against depreciation of US dollar and expected increasing inflation resulted by general financial crisis.

Current decrease in crude oil price is mainly result of lower demand in USA and Asia and increased production in the OPEC countries for 200,000 barrels per day and adjusted assessment of IEA regarding demand increase forecast in 2008 and 2009 (0.8% and 1.1% respectively).

There are many different long term forecasts for further crude oil price changes in the global market. Some analysts forecast that the crude oil price will stay at the current level or even fall to around USD 100 per barrel until 2011-2012, when some imbalance can occur on the offer side. Additional pressure on crude oil demand can be

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expected especially from emerging countries (China and India) as a result of powerful development of their economies. The Energy Information Administration forecasts the oil price increase to 186 USD by 2030 (Source EIA Global Outlook 2008)

Figure 3-4 Crude oil price in period Jan 2006 - July 2008

3.5 Petroleum industry in the Republic of Serbia

Ministry of Mining and Energy of Republic of Serbia prepares Energy balance of the Republic of Serbia on annual basis. The balance represents an overview, but also a plan for current year and following period. As the crude oil represents one of the most important energy resources, the balance pays a lot of attention to planning of production and consumption of crude oil.

Oil balance includes production of crude oil, net import of crude oil and oil derivatives, refined oil in domestic refineries and consumption of oil derivatives. Considering position of Naftna industrija Srbije in Serbian market, among other tasks the Company has to fulfill of Energy balance and provide continual offer of oil and oil derivatives. Consequently, the Company’s business plan and Energy balance of the Republic of Serbia are consistent.

Oil and oil derivatives market and whole petroleum industry in Serbia can be divided into three segments:

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� Primary energy system – Production of crude oil and natural gas, import of

crude oil and eventual export of surplus;

� Primary energy transformation system – refining of crude oil and natural gas

in refineries, and

� Final energy system – consumption of final energy for energy and non-energy

purposes (refers to distribution of products to final consumers)

3.5.1 Primary energy system – production and import of crude oil

Primary energy system refers to production of crude oil and natural gas and should provide enough primary raw materials for further production phases. Most of the crude oil and natural gas refined in Serbia is imported and only small portion comes from the domestic sources (oil and gas fields in Vojvodina and Angola).

During 2007, in oil fields in Serbia, production of crude oil totals to 640,000 tons. Plan for 2008 is to produce 635,000 tons which should cover around 19% of needs while remaining 81% or 2,630 million tons should be imported. The Figure 3-5 illustrates domestic production of crude oil and import.

Figure 3-5 Domestic production and import of crude oil

3.5.2 Primary energy transformation system – refining of crude oil

Since 2001, import of crude oil and oil derivatives is regulated by the bylaw which describes conditions for import and refinement of crude oil (latest version: Official gazette RS no. 92/2007). Bylaw is initially introduced in order to control crude oil and oil derivatives market and to facilitate full utilization and modernization of refineries in Pancevo and Novi Sad in order to prepare NIS for entrance of foreign competitors.

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Bylaw on oil and oil derivatives import and processing prevents import of basic oil derivatives (i.e. petrol and diesel) except in case of market instability threat, when NIS has a right of urgent import. The Bylaw allows import of crude oil and oil derivatives to all legal entities (license for oil and oil derivatives trading is obligatory) under condition that they have an agreement with NIS for refinement in one of NIS’s refineries. According to the Bylaw, NIS must not make discrimination regarding import and export of oil derivatives.

Changes in Bylaw from 2006 allowed free import of EURO diesel. The reason for the change was the fact that NIS’s refineries do not have sufficient capacity for production of this derivative. Domestic need for EURO diesel is increasing and reason is growth of sales of new vehicles with modern diesel engines.

Currently, Naftna industria Srbije operates two refineries – Oil refinery Pancevo and Oil refinery Novi Sad. Following figure presents refineries throughout in 2006 and 2007.

Figure 3-6 Refined crude oil in 2006 and 2007 (in tons)

Source: Naftna industrija Srbije, a.d.

In year 2007, Pancevo oil refinery and Novi Sad oil refinery together refined almost 3.5 million tons of crude oil, 83.9% of which was processed in Pancevo oil refinery and the rest (16.1%) in the Novi Sad oil refinery.

3.5.3 Final consumption and distribution of oil industry products

Consumption of final oil industry products (oil derivatives) in 2007 totaled to 4,098 million tons. For 2008, it is forecasted an increase of around 6% and planned

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consumption amount to around 4.335 million tons of oil derivates. When the annual consumption is compared to the annual production of oil derivatives, it is clear that domestic production does not cover domestic needs and the difference has to be imported.

Final consumption of oil derivatives can be divided in to groups: consumption for energy purpose and consumption for non-energy purpose. Second group, which is significantly less than the first one, refers to consumption of oil derivatives as the input for further industrial processing. Consumption of oil derivatives for non-energy purposes in 2007 reached 0.8 milion tons, with forecasted growth of 3% in 2008.

Consumption of oil derivatives for energy purpose refers to energy transforming processes in thermo-power plants, heating stations and industrial energy stations, consumption in traffic, agriculture, industry etc. The largest part of oil derivativees production is spent for traffic. Consumption of oil derivatives for traffic posts annual growth of 10% in 2008, (estimated consumtion is 2.92 million tons).

Trade and distribution of oil and oil derivatives is usually carried out through petrol station networks or direct distribution from refineries or installation of NIS (wholesale). Import of EURO diesel, which is allowed by the Changes of Bylaw on import and refinement of crude oil and oil derivatives, facilitated wholesale of this fuel to other entities. Conditions for fuel trading, among others, are ownership or long-term lease of storage capacities which can be used as a wholesale distribution center.

Petrol station network is important segment for oil derivatives distribution. Currenty, in Serbia there are several large petrol station networks which total to around 800 stations. Largest retailer of fuel in Serbia is Naftna industija Srbija (in 2006, market share was around 38%) and 486 petrol stations, followed by Lukoil-Beopetrol with 151 stations and 13% market share, OMV Srbija with 55 petrol stations and Petrobart-Avia with around 50 stations. The following figure presents number of petrol stations.

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Figure 3-7 Number of petrol station per Company

Source: Internet

3.5.4 Oil derivatives prices regulation

Since May 20th 2005, retail and wholesale prices for the basic oil derivatives (engine petrol, diesel and heating oil) are determined according to the bylaw that describes the process of price formation (Official Gazette of the Republic of Serbia 111/2005 and 77/06). Bylaw assumes monitoring of price changes of crude oil type Ural (RCMB) and RSD/USD exchange rate. If the change exceeds threshold, Government is supposed to make a valid decision of the rafinery wholesale price change (without VAT, excises and retail margin). After the decision is made, it practically becomes the sealing for retail prices in distribution.

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4 Valuation Approaches and Methodology

There are many factors to be considered during the valuation of an interest in a business enterprise. The major groups of factors to be considered are outlined as follows:

• The rights, privileges, or conditions that attach to the ownership interest, whether held in corporate form, partnership form, or proprietorship.

• The nature of the business and history of the business.

• The economic outlook that may affect the subject industry.

• The assets, liabilities, and equity and financial condition of the business.

• The earnings and dividend paying capacity of the business.

• Whether or not the business has intangible value.

• Prior transactions in ownership interests of the subject business.

• The relative size of the ownership interest to be valued and issues of control.

• The market prices of publicly traded stocks or partnership interests, acquisition prices for business interests, or businesses engaged in the same or similar lines of business.

Based on the above listed factors, available data and our professional judgment we considered all three main valuation approaches, namely the Income Approach, Market Approach and the Asset Based Approach. In valuing NIS we considered each of the above valuation approaches and related valuation methods to provide a reasonable calculation of a range of market values of equity as of the valuation date.

Within the Income Approach to value we utilized Discounted Cash Flow method.

In application of the Market Approach to value we used the Guideline Public Company (GPC) and Mergers & Acquisitions (M&A) methods.

We utilized Asset Based Approach as well. As NIS operates in capital intensive industry and is still in growing phase of development, the value of the underlying assets, when paired with Income Approach is a good indication of company’s value.

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In accordance with the points stated above, we have decided to use all three approaches. The objective of using more than one method was to develop a mutually supporting evidence to the valuation conclusion. Descriptions of the available and used valuation methods are provided in the following sections:

4.1 Discounted Cash Flow (DCF)

The discounted cash flow method takes into account (1) the stream of benefits the owner of the asset expects to receive in the future; (2) the timing of the receipt of these benefits; and (3) the risk borne by the owner of the assets. It is the only method that takes into account all three of these factors.

The discounted cash flow method is based on the premise that the value of the business enterprise is the present value of the future economic income to be derived by the owner of the business.

The discounted cash flow method requires the following analysis: revenue, expense, investment, capital structure, residual value, and discount rate analysis. Each of these factors is briefly described below.

Revenue analysis requires a forecast of prospective revenues from the sale of products or provision of services from the company for a discrete forecast period. This analysis includes consideration of market dynamics, competitive pressures, inflation, product pricing, unit production and expected growth, production capacity and economic factors impacting the industry in which the entity participates.

Expense analysis may consider fixed and variable expense categories, historical levels of variable expenses as a percent of sales, the impact of inflation on costs, the costs of borrowing and future tax rates.

Investment analysis requires a consideration of the following items: working capital requirements, capital expenditure budgets and investment policies.

Capital structure analysis examines the current capital structure, the optimal capital structure, the cost of the various components of capital, the weighted average cost of capital and company risk factors.

Residual value analysis requires a determination of the value of the business after the discrete forecast period. The residual value can be determined by a number of methods including pricing multiples or annuity formulas.

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The discount rate analysis is based on the rate of return an investor would require today, to discount the anticipated stream of payments (e.g., cash flows) in the future to their present value, based on the risk of investing in that particular business.

Based on the results of the preceding analyses, a forecast of the net future returns from the business operations is made for a discrete forecast period. The future returns can be defined as net income or cash flow. Cash flow can be further defined as equity cash flow (cash flow available to the shareholders) or invested capital (debt free) cash flow (cash flow available to both debt and equity investors). In either case the cash flow can be calculated on a pre-tax, or post-tax basis, or a real (excluding inflation) versus nominal (including inflation) basis.

The definitions of equity and debt free cash flows are presented in the table below.

Table 4-1 Equity Cash Flow and Invested Capital Cash Flow Definitions

CASH FLOW DEFINITIONS

EQUITY CASH FLOW INVESTED CAPITAL (DEBT FREE) CASH FLOW

NET INCOME +

DEPRECIATION +

INCREASES IN LONG-TERM DEBT -

INCREMENTAL WORKING CAPITAL -

CAPITAL INVESTMENT -

DECREASES IN LONG-TERM DEBT =

NET CASH FLOW AFTER DEBT SERVICING

NET INCOME

(EXCLUDING INTEREST EXPENSE) +

DEPRECIATION -

INCREMENTAL WORKING CAPITAL -

CAPITAL INVESTMENT =

NET CASH FLOW BEFORE DEBT SERVICING

DISCOUNT RATE COST OF EQUITY

DISCOUNT RATE

WEIGHTED AVERAGE COST OF CAPITAL

VALUATION CONCLUSION VALUE OF EQUITY VALUE OF INVESTED CAPITAL

(EQUITY + PERMANENT DEBT) PERMANENT DEBT IS DEDUCTED FROM THE VALUE OF INVESTED CAPITAL TO ARRIVE AT THE VALUE OF EQUITY

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It is up to the professional judgment of the appraiser to determine the appropriate definition of the future returns to use based on the facts and circumstances of each case. Regardless of the basis for computing cash flow (equity or debt-free), non-cash items (e.g., depreciation and amortization) should be added and capital expenditures should be deducted to arrive at the available cash flow. In the case of NIS, a nominal, debt-free cash flow was used.

In all cases, the discount rate used must be calculated on the same basis as the future cash flow stream to which the discount rate is applied. For example, an equity cash flow would use an equity cost of capital, while a debt free cash flow would use a weighted average cost of capital (WACC). In addition, the discount rate must also be estimated on a real or nominal basis in order to match the cash flows of the projections. In the case of NIS, since a nominal, debt-free cash flow was used, a nominal weighted average cost of capital was applied to the cash flows.

The residual value is capitalized by subtracting long-term growth rate from weighted average cost of capital (WACC).

After determining the discount rate, the future returns and residual value are discounted to determine the present value. The sum of the present values represents the value of the equity in an equity cash flow model, and the value of the invested capital (equity plus interest bearing debt) in the debt free model. Interest bearing debt must be subtracted in the latter case to arrive at the value of the equity. Depending on the circumstances of the appraisal, this preliminary estimate may be adjusted for other factors such as control and marketability.

4.2 Market Approach

The Market Approach is based on the capital markets data and is designed to determine the value of the business entity by comparing the subject company to (1) comparable firms (guideline public companies) whose shares are publicly traded on organized capital markets (Guideline Public Company Method) and/or (2) guideline companies that have been bought or sold during a reasonably recent period of time (Mergers and Acquisitions Method).

In either case, an appropriate sample of guideline companies is selected based on comparability criteria. Ideal guideline companies are those, which are in the same industry as the subject company with comparable operations in terms of products, diversification, economic influences, and size among other factors. Usually a minimum of 3 to 5 guideline companies are required to create a meaningful sample for either the GPC or Mergers and Acquisitions method.

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For each firm in the sample of guideline companies, several value indications or pricing multiples are calculated. Examples of pricing multiples include: price to earnings, price to cash flow and price to book value. After these multiples are calculated for each comparable company, an appropriate value multiple is selected for the subject company based on a thorough analysis of the subject company’s risk and financial characteristics compared to the comparable companies sample. This multiple is then applied to the appropriate financial data (e.g., earnings, cash flow, book value) of the subject business.

As well as in DCF, multiples can be defined as either equity or invested capital multiples. In latter case, interest-bearing debt should be deducted from the previous result.

The result of applying the valuation multiple to the subject firm’s financial data results in a preliminary estimate of market value. Depending on the circumstances of the appraisal, this preliminary estimate may be adjusted for other factors such as issues of control and marketability.

4.3 Asset Accumulation (Cost) Approach

The asset accumulation method is an indirect approach for determining the value of the business enterprise. Using this method, the fair market values of all of the Company’s assets are discretely determined and accumulated. This approach, therefore, requires a discrete appraisal of the following types of assets:

• Current assets such as cash inventory, marketable securities, and accounts and notes receivable and prepaid expenses;

• Tangible assets such as land and buildings, furniture and fixtures, machinery and equipment, etc.; and,

• Intangible assets such as: goodwill, going concern value, customer lists, trained work force, trade name, patents and proprietary technology, etc.

The value of each of these assets is individually determined based on the appropriate valuation methods for each class of assets. The assets values are then totalled to arrive at the fair market value of all of the tangible and intangible assets of the business. The values of all liabilities, recorded and unrecorded, are determined and summed to arrive at the fair market value of the firm's liabilities.

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The restated liabilities are then subtracted from the total asset value to arrive at the estimate of the fair market value of the owners' equity. This is also the value of the business enterprise, per the asset accumulation method.

However, this approach does not reflect the return those assets should generate to warrant an investment at these values. If a discounted net cash flow valuation of a business indicates that the value of the business entity is less than the depreciated replacement cost of the component assets, then economic obsolescence exists. In this case, all assets should be reduced in value to the level of economic support indicated. An investor will reduce the amount he is willing to pay for the assets of a business until the projected cash flows provide an adequate return on the investment given the level of risk in owning the assets.

4.4 Summary - Business Valuation Methods

The method or methods selected in each individual business valuation assignment depend upon the appraiser's judgment and experience with similar valuations and upon the quantity of available financial, operational, and industry data.

In order to value fair market value of 100% of equity of NIS, we utilized the Discounted Cash Flow method, the Guideline Public Companies method, Mergers & Acquisition method and the Net Asset method.

The results of the Discounted Cash Flow method, the Guideline Public Companies method, Mergers & Acquisition method and the Net assets method are discussed in the following Sections of this report.

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5 The Cost Approach - the Net Assets Value Method

The Net Asset Value Method is based on the determining the fair market value of the Company’s all assets and liabilities as of the valuation date. The value of equity is determined as a difference between the value of all assets and all liabilities. Therefore, we divided all Company’s assets and liabilities into categories and appraised each category and type of assets and liabilities using the appropriate methodology.

The Company’s assets and liabilities as of the valuation date are divided into the following categories:

• Intangible assets – including concessions, software and other intangible assets,

• Property, plant and equipment – real property, machinery and equipment, investment property, etc.

• Long-term financial investments – consisting of ownership share in other businesses and long term loans granted.

• Current assets – group that consists of assets such as receivables, inventories, cash and cash equivalents and similar.

• Long-term liabilities – that consist of provisions, long-term borrowings, and other various financial liabilities.

• Short term liabilities –mainly consistent of trade payables, short-term borrowings, and other short term financial obligations.

The first step in application of the NAV was to reclassify certain assets and liabilities of NIS as of 30 June 2008. The reclassification was necessary in order to convert the reported balance sheet to be consistent with International Financial Reporting Standards (IFRS), as well as to make necessary valuation normalizations.

Following the initial reclassifications, we made accounting adjustments to the balance sheet items that meet the requirements of International Financial Reporting Standards (IFRS).

The next step in the process of the NAV method was to separately appraise all assets and liabilities identified as of the valuation date. In the course of valuation of certain real property and machinery and equipment we relied on the independent appraisals performed by the industry specialists.

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Only, after we completed the above steps, we were able to make a conclusion about the value of the Company’s equity as of 30 June 2008 as the difference between the fair market value of all assets and liabilities.

5.1 Reclassifications to the reported balance sheet as of 30 June 2008

As already stated, our first step in application of NAV was to reclassify the Company’s balance sheet as of 30 June 2008. The reclassifications made are provided in the table below

Table 5-1 Reclassifications to the reported balance sheet as of 30 June 2008

Balance sheet NoteAs reported as of 30 June 2008

ReclassificationsReclassified as of

30 June 2008

FIXED ASSETS 1,423,620 38,997 1,462,617 Intangible assets 55,197 - 55,197

Property, plant and equipment 6.1.1 1,222,098 17,063 1,239,161 Property, plant and equipment 1,212,742 (82,724) 1,130,018 Investment property 9,356 99,787 109,143

Long-term financial placement 6.1.2 146,324 21,934 168,258

CURRENT ASSETS 6.1.3 789,578 (38,997) 750,581 Inventories 486,637 (28,049) 458,588

Receivables, financial placements and cash 296,768 (10,948) 285,820 Receivables 7,855 - 7,855 Advances 206,187 - 206,187 Short-term financial placements 21,778 (17,727) 4,051 Cash & cash equivalents 34,636 6,779 41,415 VAT and prepaid expenses 26,313 - 26,313

Deferred tax assets 6,173 - 6,173

TOTAL ASSETS 2,213,198 - 2,213,198

TOTAL EQUITY 1,309,411 - 1,309,411

LONG-TERM PROVISIONS AND LIABILITIES 6.1.4 174,167 (12,586) 161,581 Long-term provisions 15,220 30 15,250

Long-term liabilities 158,947 (12,616) 146,331 Long-term borrowings 156,702 (12,616) 144,085 Other long-term liabilities 2,246 - 2,246

SHORT-TERM LIABILITIES 6.1.4 729,620 12,586 742,206 Short-term financial liabilities 334,933 12,616 347,549 Payables 275,580 (30) 275,551 Other short-term liabilities and accruals 87,715 - 87,715 VAT and other public revenues 39,681 - 39,681 Income tax liabilities (8,289) - (8,289)

TOTAL LIABILITIES 903,787 - 903,787

Source: NIS and Deloitte calculations

Since each of the reclassifications consists of several items, we will describe them individually:

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5.1.1 Property, plant and equipment

During the examination of the list of the company’s property, plant and equipment we identified the real estate properties that are used by the Company but could be put at small or no cost to a more productive use (the highest and best use). These real properties as of the valuation date were reported at EUR 99,787,000. For the valuation purposes we reclassified the above real property as the investment property.

We also identified a significant number of housing apartments that are provided to the company’s employees reported as property plant and equipment. The above apartments are gradually repaid to the Company by the tenant employees and reported at the amount of expected proceeds from the tenants. Due to the nature of these assets we reclassified them as long-term financial placements in the total amount of EUR 10,986,000.

We have also identified inventory of spare parts that are vital to the functioning of the Company’s plants that were reported in the total amount of EUR 28,049,000. We reclassified these inventories of spare parts to other property, plant and equipment.

5.1.2 Long-term financial placements

Long-term financial placements are increased in carrying value of the apartments (EUR 10,986,000) that were reclassified from the Company’s property, plant and equipment as stated above.

In order to more easily determine the value of non-operating assets, we reclassified current portion of the long-term financial investments from short-term receivables to long-term financial investments. The amount of current portion of the long-term financial placements reclassified totals EUR 13,502,000.

Shares that were recorded as long-term investments in the Company’s balance sheet in the net value of EUR 2,554,000 are reclassified as marketable securities and part of the Company’s current assets.

5.1.3 Current assets

As previously stated, the spare parts that are vital to the functioning of the company’s plants, in the total amount of EUR 28,049,000, are reclassified from inventory to property, plant and equipment.

The Company reported short-term financial placements in the total amount of EUR 21,778,000. As metioned before, we reclassified current portion of the long-term loans granted in amount of EUR 13,502,000 to long-term financial placements and

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reclassified EUR 2,554,000 of long-term investment to marketable securities that is a part of current assets.

In addition to the above, we reclassified the amount of EUR 6,779,000 from bank deposits, which were reported as short-term financial placements, to cash and cash equivalents.

5.1.4 Long-term and short-term liabilities

We reclassified the amount of EUR 30,000 that was recorded as a payable to the other long-term provisions.

During the examination of long-term borrowings, we identified that the current portion of long-term debt was not reclassified as part of short-term financial liabilities. The amount of current portion of the long-term financial borrowings reclassified totals EUR 12,616,000.

5.2 Adjustments to the reclassified balance sheet as of 30 June 2008

After the reclassification of the reported balance sheet as of 30 June 2008, we made adjustments to the balance sheet items in order to get the appraised values. Adjustments are made in accordance with the International Financial Reporting Standards (IFRS) and independent appraisals of the Intangible assets, Property, plant and equipment and inventories.

5.3 Intangible assets

5.3.1 Introduction

Apart from tangible property, plant and equipment as of the valuation date NIS owned significant intangible assets. Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured. Intangible assets are created either through time and/or effort and they are identifiable as assets separate from tangible assets. There are two primary forms of intangibles - legal intangibles and competitive intangibles (such as know-how). Legal intangibles generate legal property rights defensible in accordance with law, while competitive intangibles, whilst legally non-ownable, directly impact effectiveness, productivity, and/or profitability of the company. Human capital is the primary source of competitive intangibles for organizations today.

In accordance with IFRS, intangible assets are reported at cost. Only if the intangible assets are acquired as a part of a business, and their value verified in such a way, they

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are reported in the consolidated financial statements. In the case of NIS all intangible assets have been reported at cost.

As the first step in the valuation of intangible assets we identified those intangible assets that are not reported in the financial statements of NIS. We identified two significant intangible assets that are not reported in the financial reports of NIS as of the valuation date:

- Trained and assembled workforce and

- Crude oil and natural gas research, exploration and extraction concession rights in Serbia

For the intangible assets reported in the financial statements of NIS as of the valuation date we have analyzed whether there are any future economic benefits from the possession of individual intangible assets over the remaining useful life of such assets. At the same time we analyzed whether there are evidences of impairment of intangible assets as of the valuation date. Most of the intangible assets reported in the financial statement relate to intellectual property such as computer software, technical plans, and technical drawings and specifications reported at cost that fairly reflects the going market value of those intangible assets.

5.3.2 Trained and assembled workforce

A trained and assembled workforce is a highly valuable intangible asset that allows undisrupted operations of business. Apart form value in use of the assembled workforce that is in an efficient labor market reflected in the going rate of wages, the current workforce provides costs saving of assembling the existing workforce. In valuing trained and assembled workforce we assumed that considerable expenditures for recruiting, selecting, and training would be required to replace these employees with individuals of comparable skills and expertise. In a hypothetical acquisition of a business the buyer by acquiring fully trained personnel would avoid the expenditures associated with hiring and training equivalent personnel. The value of the assembled workforce is represented by the assembly cost avoided. Therefore, the cost approach is the most applicable valuation approach to value this asset. Using this approach, the costs associated with employee recruitment, selection, and training provide the measurement of value.

Recruiting costs are incurred to obtain a new employee, who may be either untrained or previously trained. The major components of recruiting costs are employment agencies, advertising, and other recruitment-related expenses. We differentiated the current workforce of NIS in five educational categories:

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1. Non-qualified workforce,

2. High school educated workforce,

3. Qualified workforce,

4. Workforce with some college education, and

5. College educated workforce.

We assumed that each category of workforce has different specific recruitment costs that are increasing with the educational level of the workforce. The estimated recruiting costs as percentage of the average annual salary costs per employee are provided in the following table.

Table 5-2 Recruitment costs as percentage of annual salary

Workforce category Recruitment costs as % of annual salary

Non-qualified workforce 0%

High school educated workforce 0%

Qualified workforce 8%

Workforce with some college education

13%

College educated workforce 25%

Source: Deloitte calculations

We assumed that non-qualified and high-school labor is abundant and it does not require extra recruitment costs. As opposed to non-qualified workforce, shortage of the qualified workforce is evident in the market and therefore it is significantly more costly to acquire qualified workforce.

Training costs are incurred to train employees and bring them to the level of performance normally expected from an individual in a given position. The training costs of an employee reflect the amount of time inefficiently used by a new employee (inefficiency training cost) and the time inefficiently used by a training supervisor (direct training cost) during the first few months on the job. Training and supervisory costs were estimated as a percentage of reduced productivity and estimated length of reduced produ