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7/25/2019 Week+5+Case
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Week 5 Case
Faisal Hassan Al Abdulmalik
American Public University
8 Jan, 201
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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?
W!enever a "irm !as m#re t!an t$# divisi#ns, it must n#t use a c#m%any&$ide c#st #"
ca%ital "#r analy'in( t!e ca%ital e)%enditures in all its business units* +!e reas#n "#r t!is is
t!at eac! divisi#n %#ses di""erent risk t# t!e "irm and eac! #ne #" t!em !as di""erent
investment #%%#rtunities t# be c#nsidered* Here t!e "#ur divisi#ns i*e* u%stream,
d#$nstream, c!emical and (l#bal services all !ave risks #" uni-ue natures* .easurin( t!em
all by a sin(le disc#unt rate d#es n#t seem t# be an a%%r#%riate met!#d* Usin( di""erent
interest rates t# evaluate e""ect #" e)%ected cas! "l#$s "#r di""erin( time %eri#ds $ill result in
better decisi#ns and s#und analysis #" t!e c#m%anys value* /in(le c#m%any&$ide rate $ill
actually (ive a rate t!at mi(!t be t## !i(! "#r l#$ risk divisi#ns and t## l#$ "#r !i(! risk
divisi#ns t!ereby makin( t!e "irm acce%t bad !i(! risk %r#ects and reect (##d&l#$ risk
%r#ectsinvestments* +!ere"#re, usin( c#m%re!ensive divisi#nal cut"" rates re"lects t!e
a%%r#%riate riskiness #" t!e divisi#n t!at $ill als# be !el%"ul in usti"yin( t!e %#litical
rivalries $it!in t!e "irm 3ru(er, 4andier, +!esmar, 20116*
If you were to evaluate divisional costs of capital, how would you go about estimating
these costs of capital for ExxonMobil? iscuss 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!
7n #rder t# calculate t!e c#st #" ca%ital "#r %articular divisi#ns, ))#n.#bil $ill need
t# calculate t!e c#st #" e-uity and c#st #" debt se%arately "#r eac! divisi#n and t!en calculate
t!eir res%ective c#st #" ca%ital* +!e c#st #" e-uity "#r t!e "irm is calculated by estimatin( t!e
beta usin( t!e security market line* /ince "#r eac! divisi#n t!ere $ill n#t be any se%arate
st#cks t!ereby makin( it im%#ssible t# calculate t!e betas directly s# an indirect a%%r#ac!
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$ill be used* +!e best met!#d is t# "ind stand&al#ne c#m%anies t!at are c#m%arable t# eac! #"
t!e divisi#n* +!ese betas are t!en adusted "#r t!e "inancial levera(e s# t!at t!e variati#n in
t!ese c#m%arable c#m%anies due t# variati#n in t!e "inancial levera(e is eliminated* +!e ne)t
ste% is t# calculate t!e avera(e 9unlevered beta "#r eac! divisi#n, $!ic! can "urt!er be used
in t!e security market line in #rder t# calculate 9%ure&cut#"" rate* +!e unlevered beta
t!e#retically is re&levered at a rate t!at is used "#r eac! divisi#n* :nce t!e beta is kn#$n by
usin(, t!e CAP. c#st #" e-uity "#r eac! divisi#n can be estimated C#llier, ;rai, Haslit,
.c;#$an, 2006*
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"eferences
C#llier, H* W*, ;rai, +*, Haslit, /*, .c;#$an, C* =* 2006* Computing the divisional cost
of capital using the pure play method.W#ll#n(#n(@ University #" W#ll#n(#n(*
3ru(er, P*, 4andier, A*, +!esmar, * 20116* The WACC Fallacy: The Real Effects of Using
a Unique iscount Rate..ann!eim@ University #" .ann!eim*
Parasuraman,