ExxonMobil ( XOM) is one of the half- dozen major oil companies in the world. Th
ID: 2654426 • Letter: E
Question
ExxonMobil ( XOM) is one of the half- dozen major oil companies in the world. The firm has four primary operating divisions ( upstream, downstream, chemical, and global services) as well as a number of operating companies that it has acquired over the years. A recent major acquisition was XTO Energy, which was acquired in 2009 for $ 41 billion. The XTO acquisition gave ExxonMobil a significant presence in the development of domestic unconventional natural gas resources, includ-ing the development of shale gas formations, which was booming at the time. Assume that you have just been hired to be an analyst working for ExxonMobil’s chief financial officer. Your first assignment was to look into the proper cost of capital for use in making corporate investments across the company’s many business units.
a. If you were to evaluate divisional costs of capital, how would you go about estimating these costs of capital for ExxonMobil? Discuss how you would approach the problem in terms of how you would evaluate the weights to use for various sources of capital as well as how you would estimate the costs of individual sources of capital for each division.
Explanation / Answer
Solution-
In the estimation of the cost of capital for Mobil, I would use the discounted cash flow technique of estimating cost of capital to a firm. This would enable me to estimate the firm’s cash flows and determine the weighted average cost of capital at which the company’s cash flow will be discounted. I would them n then choose a period of a five year period in which I would forecast the cash flows of the projects to be undertaken within the divisions in the company.
To determine the weights to assign to the various sources of capital I would, analyze the weights based on the sources of capital that the company uses. The source of capital could either be from Debt, preferred stock and common equity. I would then assign the weights basing on the market values of the sources of capital that the company uses. However, if all market values of the sources of capital are not readily available, I would use the book values for the debt and market values for equity.
To estimate the individual costs of capital for each division, I would assume that the divisions of the company use either debt or Equity as sources of financing. The cost of equity is the rate that the company investors would expect to receive from investing in the company’s stock. The estimation of cost of equity is difficult because they do not have a contractually defined return, I would therefore apply the capital asset pricing model to determine the cost of capital to the company’s division. To determine the cost of debt which is the rate of return to the company’s lenders for the funds loaned. I would therefore determine the cost of debt by estimating the market required rate of return using the yield to maturity of the company’s debt.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.