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?
No. I would not recommend ExxonMobil to deploy a single company-wide cost of capital in analyzing different capital expenditures in diverse business units. Department experience different levels of risks as well as various structures of cost. In this case, the company-wide cost of capital needs to be adjusted based on each business unit with the motive of attaining significantly accurate business decisions ( Berger, Chen & Li, 2018) . Therefore, the use of company-wide cost of capital may result in the company dropping some of the projects which are potentially acceptable. Additionally, the company may end up accepting projects that are likely financially unviable.
Delegate your assignment to our experts and they will do the rest.
Capital projects require large investments as well as future investments, and poor decisions can lead to long term losses in the company’s finances which may impair the company’s existence ( Berger, Chen & Li, 2018) . Capital projects’ main purpose is to increase the company’s value which can be visualized through stock price changes over some time. Proper use of the cost of capital is important and varies from one company to the other. Using the most effective cost of capital that is based on the individual company’s level of risk per department in the most realistic approach to deploy.
Additionally, it is imperative to note that ExxonMobil’s company-wide cost of capital can be divided based on the departmental use of capital in consideration of debt and equity of each department. Departmental evaluation of the cost of debt as well as equity and adjustment of the risk factors are implemented in the determination of comparable and accurate cost of capital ( Berger, Chen & Li, 2018) . Subsequently, the cost of capital is used in the evaluation of the different departmental projects.
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.
In determining the accurate weighted average cost of capital per department, I would estimate the cost of capital for each division. Cost of capital entails the cost of an individual capital resource such as the cost of debt, cost of preferred stock and cost of equity. Since debt allocation to any particular departmental is used in the determination of the cost of debt, determination of after-tax cost of debt is quite easy and straight forward ( Frank & Shen, 2016) . After determining the average cost of debts of any particular department, tax impact adjustments can be made in the determination of the after-tax cost of debt. The cost of equity can be arrived at based on the allocated cost of common stock which can be derived by either the dividend discount model or the Capital Asset Pricing Model (CAPM) ( Frank & Shen, 2016) . However, I would prefer to use the CAPM model in the determination of the cost of equity
CAPM model formula:
Given Rf is the risk-free rate from the treasury bond yield. Rm is the rate of the market expected by the specific department based on market expectation and performance. On the other hand, the determination of the association of the risk factor with the overall company. Based on this, the company’s equity is determined.
The cost of preferred stock is readily determined by evaluating the current stock’s preferred yield. Determining the weights of the sources of capital, the total value of the capital is assessed based on the current market price. In this light, a summation of the total debt’ market value, the total market value for equity per particular department and the assigned preferred department stock’s total market value is used to determine the total capital value assigned to an individual department ( Frank & Shen, 2016) .
The elements of the weighted cost of capital are used as a basis for determination of the weights of a specific cost element ( Frank & Shen, 2016) . The cost of capital is used in the evaluation of projects in various departments with the objective of determining the accurate review of the project as well as the acceptance of the project.
References
Berger, P. G., Chen, H. J., & Li, F. (2018). Firm specific information and the cost of equity capital. Feng, Firm Specific Information and the Cost of Equity Capital (April 2, 2018) .
Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics , 119 (2), 300-315.
