ExxonMobil Cost of Capital
Mini-Case 9-2 (Chapter 9)
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. Would you recommend that ExxonMobil use a single company- wide cost of capital for analyzing
capital expenditures in all its business units? Why or why not?
b. 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.
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Instructions: In 600-750 words in length (not including title page and reference page), respond to the case
below. Your paper must include at least two scholarly journal references (in addition to your book). Refer
to the Writing Assignment Grading Criteria below for requirements in content, organization, writing style,
grammar and APA 6.0 format.
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ExxonMobil Cost of Capital
Introduction
A company can use either cost of equity or cost of debt while acquiring finances for
development. The cost of equity is used to finance the business for a short term basically less
than one year or one year. The cost of debt is used to fund the business for a long-term period
such as five years. Due to stiff competition, companies are multi-tasking their projects and they
end up using both cost of equity and cost of debt to run their operations, (Hou, Van Dijk, &
Zhang, pg. 507, 2012).ExxonMobil is one of the largest oil company in the world. The company
has several daughter companies in the international market arena and it has merged and acquired
companies such as XTO energy.
The company’s operations are segmented from upstream to downstream to chemical
segment and global services. To finance all its operation and to maintain its market share
globally, the company use both cost of equity and cost of debt as their cost of capital to run its
operations.According to Brennan, Huh, &Subrahmanyam(2015) the company has recorded 5.6%
as a cost of equity which it pays to the equity investors and it also have cost of debt amounting to
4.01%. ExxonMobil cost of capital is resultant of the weighted average cost of capital (WACC).
It means that a company’s cost of capital signify the hurdle rate which the organization is
mandated to overcome before it create worthiness, (Brennan, Huh, &Subrahmanyam, pg. 87,
2015).
Single company- wide cost of capital
ExxonMobil can use a single company- wide cost of capital for analyzing capital
expenditures in all its business units. It is because cost of capital are resulting from weighted
average. García, Saravia, &Yepes (2015) argued that when the organization uses WACC, it will
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help the top management to define the company’s “economic feasibility of expansionary
opportunities and mergers”. When the company wishes to launch another new project or to
advance on its current projects, the company should consider the level of risk as compared to the
company total risk. If the project is of higher risk, the discount rate should be higher than that of
the company’s WACC and if it’s of lower risk, the discount rate should be lower than that of
company’s WACC, (García, Saravia, &Yepes, 2015) The Weighted Average Cost of Capital
method gives a company an informed decision making when deciding on whether to finance a
project or not due to risk factor.
Also, since ExxonMobil operate in international market arena, the top management
should understand the concept of capital budgeting in foreign market is complicated that capital
budgeting in domestic market. Various factors can impact on the company capital budgeting. For
example the inflation rate of the foreign country. Inflation rate are in capacity to affect the cash
inflow and outflow of the project been initiated. Other factors such as exchange are make the
project complicated since all the calculation are done by the parent company them converted by
the foreign exchange rate and since there is fluctuation in exchange rate, it becomes complex and
this may force the company to use higher discount rate than overall company’s WACC, (García,
Saravia, &Yepes, pg. 115, 2015).
In addition, the company may opt to analyze other companies that operate in the same
line of business such as energy giant BP and be in a position to work out their WACC. The
discount rate the company uses, would be the same number that will be used by ExxonMobil. If
it’s a virgin market, it becomes subjective and difficult to analysis the market risk.
Evaluating divisional costs of capital
Estimating costs of capital for ExxonMobil
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ExxonMobil operates in global market. It has project in the arena and each project is
associated with its costs. To approximate the cost of capital for each, the company should opt of
using beta. Beta are meant to weigh macro risks of the business (Frazzini, & Pedersen, 2014).
With this, the company can approximate the cost of equity for each project by using a given
currency such as euro risk free rate and the equity premium in euro terms. Also, the company can
approximate the default distributed by the company through the use of its variance in its
securities prices. If its operation are within a market with sovereign default risk, the default can
be distributed to the company business and this will result to the top management to use the
marginal tax rate of the foreign country to approximate its after tax debt.
The company can assign each division main core business by approximating their risks. It
would use the unlevered beta for a given division as compared to that of the company. This will
help the company to calculate the unlevered beta for each segment by incorporating all business
they engage in and they will be able to estimate cost of each division, (Frazzini, & Pedersen, pg.
25, 2014).
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References
Brennan, M. J., Huh, S. W., & Subrahmanyam, A. (2015). Asymmetric effects of informed
trading on the cost of equity capital. Management Science
Frazzini, A., & Pedersen, L. H. (2014). Betting against beta. Journal of Financial Economics,
111(1), 1-25.
García, C. S., Saravia, J. A., &Yepes, D. A. (2015). The weighted average cost of capital over
the lifecycle of the firm: is the overinvestment problem of mature firms intensified by a
higher WACC?.
Hou, K., Van Dijk, M. A., & Zhang, Y. (2012). The implied cost of capital: A new approach.
Journal of Accounting and Economics, 53(3), 504-526.
