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The ExxonMobil Company’s Capital Cost Analysis Research Paper

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Updated: Jun 19th, 2022

ExxonMobil (XOM) is an international company that deals with oil products. The company is based in Texas, and it has been expanding its business over the years. The company has existed for over two decades. It is increasing because the world is in a dire need of energy, and XOM is never hesitant to meet these expectations. To build new units, the business will need proper analysis of the capital cost to ensure that it operates smoothly.

The Use A Single Company-Wide Cost of Capital

The use of a single wide cost of capital will be crucial in XOM’s case since it weighted average into consideration. According to Frank and Shen (2016), the WACC system’s use enables the directors and the decision-makers of the company to determine the economic practicability of engaging in business expansion and mergers. Suppose XOM wishes to either expand the business or build new units. It should also determine the risk associated with the new venture and compare it to the total risk that the firm has taken. XOM’s WACC should be lower than the discounted rate, if the new project is of high risk and vice versa. In other words, the WACC technique examines the risk factor, hence promoting sound decision making.

Moreover, being that XOM is an international organization, which means that it operates in many countries worldwide, the company’s directors should conceive the idea that capital budgeting is complex. This is because numerous external and internal factors can influence the process of capital budgeting. For instance, the inflation rate is an external factor that can affect the company’s budgeting process. This is due to its capability to interfere with the flow of money used in the project. Additionally, the exchange rate affects the capital because the budget is performed at the headquarter of XOM based in Texas, US. After the budgets have been done, the amounts are converted to the country’s currency, where the project is initiated. As a result, the process is affected due to currency fluctuation rates, forcing XOM to use a high-value discount rate compared to the total XOM’s WACC.

Additionally, XOM can analyze other big companies that engage in similar business and determine their WACC, such as BP. This implies that XOM company will use the same discount rate the competitor is using. Although it is an effective idea, it becomes complex when it is a new market because it is challenging to analyze the market risk. Moreover, the competitors can be unwilling to disclose their WACC.

Evaluating Divisional Costs of Capital

Companies that operate in international borders requires the use of beta to determine their sources of capital. Therefore, XOM will apply the same technique of beta to estimate the cost of capital of each unit. In the event that the company initiates numerous projects, each project has its own cost. Therefore, I would use the approach to evaluate the amount of capital invested in each division by using the current market price to calculate the total value of the invested capital. Summation of the market value of the equity, debt, and preferred stock allocated to each division will yield the overall market value billed to a unit. According to Berg and Mark (2018), beta enables the company to analyze an organization’s macro risks. Therefore, XOM will use the currency of their country of operation to calculate the equity cost of their activities.

Additionally, the security prices of XOM will enable the firm to determine its default risk. However, if XOM conducts business in market with independent default risk, the default will be distributed equally to other divisions. As a result, the officials of XOM based in Texas will regulate the after-tax debt after calculating the marginal text of the overseas countries. Therefore, XOM can delegate primary functions to each business after estimating the associated risks.

In conclusion, XOM can determine the cost of individual projects it is undertaking. Although this will be difficult because of the market forces that are complex to tackle, XOM can use the beta technique to evaluate the risks associated with the project. As a result, the directors of the company will be able to determine the economic viability of all their programs. Additionally, XOM will be able to determine the cost of individual projects, therefore, enabling the business to venture into profitable activities.

References

Berg, K. A., & Mark, N. C. (2018). Global macro risks in currency excess returns. Journal of Empirical Finance, 45, 300-315. Web.

Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315. Web.

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