Petrobras cost of capital case study ~ Why 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

Does 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")

The 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 firm)).

Is 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 affect competitiveness?

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.

Work cited

Lee, Tim, Eric Hu, and Tim Philips. "FNCE 404 Case". prezi.com. N.p., 2013. Web. 10 Nov.

2016.

"Petrobras Cost Of Capital". documents.mx. N.p., 2014. Web. 10 Nov. 2016.

The sovereign spread is technically the international debt markets‟ opinion