do you think Petrobrás’s cost of capital is s...
do you think Petrobrás’s cost of capital is so high? Are there better ways, or
other ways, of calculating its weighted average cost of capital?
Petrobras was a
Brazilian oil company that was uniquely domestic in its activities thus
producing for Brazilian markets. On the other hand, most established
multinational oil firms are treated in an equal manner with the assessment of
their earning potential compared as well as costs of capital. It’s reported
that other major oil companies were considered to have lower relative risk
while having a relatively lower cost of capital due to the magnitude of their
export sales. There is an argument that the cost of capital of the firm should
not be “troubled” by the additional charges of the Brazilian sovereign spread
when it comes to calculating its cost of equity and debt. It’s operating in a
global industry with a global market and a global price (U.S dollars) which
could be accessed for sale if the firm wished. There are numerous ways to
calculate a company’s cost of capital but most methods would need addition of
some risk premium to somehow compensate investors for the perceived Brazilian
country or political risks
this method of using the sovereign spread also compensate for currency risk?
The sovereign spread is
the opinion of the international debt market of Brazil’s creditworthiness when
borrowing America’s dollar-denominated debt (not similar to currency risk).
What’s interesting is that Petrobras’ share price had shown a high correlation
with the EMBI+ sovereign spread for Brazil. The spread would reflect changes in
the exchange rate irrespective of its theoretical validity as long as it’s used
by investors in calculating the cost of capital of the company ("Petrobras
Cost of Capital")
final quote on “one’s view on the direction of the broad Brazilian market”
suggests that potential investors consider the relative attractiveness of
Brazil in their investment decision. How does this perception show up in the
calculation of the company’s cost of capital?
The perception of a
risky investment creates Petrobras’s higher cost of capital reflected in the
market risk premium (Lee, Hu and Philips). The weighted average cost of capital
is calculated by;
Weight average cost =
(risk-adjusted cost of the equity (market value equity/ market value of firm))
+ (before tax cost of debt (1- tax rate) (market value debt/ market value of
the cost of capital really a relevant factor in the competitiveness and
strategy of a company like Petrobrás? Does the corporate cost of capital really
A company like
Petrobras considers the cost of capital critically important as a factor
considering a company’s competitiveness. It’s also important since Petrobras is
operating in one of the world’s most capital-intensive industries. The company
is projected to have rates of return exceeding the cost of capital i.e. as the
cost of capital goes high, the consideration of potential investment lessen and
the fewer potential investments are likely to be conducted.