Case Study: Cost of Capital

Presented by:

Aditya Syamsu Bhagas Arga Hanif Widyanto Irreza Irreza

Backstory
Corporate Actions

Petroleo Brasileiro S.A (Petrobras) is an integrated oil and gas company founded in 1954 by the Brazilian Govt. Listed in Sao Paulo in 1997, and NYSE in 2000 (Govt still the controlling shareholder). 1. December 2001, exchange of operating assets with Repsol YPF of Argentina. 2. October 2002, purchased Perez Company of Argentina.

Problem
Renewed discussion of a new equity issuance
Intended to increase its equity capital

High cost of capital compared to competitors

CoD 9%, CoE 14,05%, WACC 11.53%

Petrobras needs to diversify

Strong domestic presence only

CASE QUESTION 1
Why Petrobras Cost of Capital is so high? Are there better ways, or other ways, of calculating its WACC?

CASE QUESTION 1

ANSWERS:
Petrobras has high cost of capital because: Country risk factor inherently linked to Brazil
Reflected in its sovereign risk in Kd

Lack of diversification in its equity market

Petrobras only issued its shares in Sao Paolo and NYSE

CASE QUESTION 2
Does this method of using sovereign spread also compensate for currency risk?

CASE QUESTION 2

ANSWERS:
NO. Sovereign Risk is more closely related to Country Risk There is still Currency Risk factors from difference in Debt Issuance Currency and its Functional Currency
Petrobras uses R$ as its functional currency

CASE QUESTION 3
The final quote that ones view on the direction of the board 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 Petrobras cost of capital?

CASE QUESTION 3

ANSWERS:
Kd = Risk Free Rate + Sovereign Risk + Corporate (Petrobras) Risk
Sovereign Risk reflects the Country Risk and Potential Returns that Petrobras could provide

CASE QUESTION 4
Is the cost of capital really a relevant factor in the competitiveness and strategy of a company like Petrobras? Does the corporate cost of capital really affect competitiveness?

CASE QUESTION 4

ANSWERS:
Cost of capital is a relevant factor in measuring the competitiveness of Petrobras Such high cost of capital is not competitive compared to other competitors within the industry

Current Condition
Petrobras has issued its shares in Brazil, NYSE, Madrid and Buenos Aires. The last second issuance in Madrid has made Petrobras the 4th largest company in terms of market capitalization in the world. Petrobras has operated in 27 countries Petrobras Issuance of Debt has increased until 50% debt to equity ratio (up from 33% in 2005)

Conclusion
Petrobras decided to decrease its WACC by diversifying its market equity, so the external factors could alter its global market equity premium and its beta Petrobras has increased its debt with lower cost of debt until 2012