A Look At Cost Of Capital Decisions At Exxon Mobile

895 words - 4 pages

A Look at Cost of Capital Decisions at Exxon Mobile

American Military University
This paper discusses and analyses the cost of capital decisions Exxon Mobile faces after its acquisition of XTO Energy. The advantages and disadvantages of both single company – wide cost of capital and divisional costs of capital are detailed. Finally, the method of estimating the costs of capital and determining how Exxon Mobile could best evaluate the weights to use for various sources of capital is discussed.
A Look at Cost of Capital Decisions at Exxon Mobile
Due to its recent acquisition of XTO Energy, Exxon Mobile must reevaluate how it determines the proper cost of capital for use in ...view middle of the document...

In contrast to the company – wide method of figuring cost of capital, the divisional method provides many benefits. The divisional weighted average cost of capital or Divisional WACC is used when a corporation like Exxon Mobile have multiple operating divisions, each with their unique risk (Keown, Martin & Petty, 2014). The acquisition of XTO Energy represents of another division that poses a higher risk to Exxon Mobile than some of its other divisions. Divisional WACC provides different discount rates according to the different risks posed by different divisions (Keown, Martin & Petty, 2014). For example, assuming at the time of the XTO Energy acquisition Exxon Mobile is using a company – wide cost of capital of 12% and the natural gas development division, which XTO energy represents, requires 17%. Using this example Exxon Mobile would be over investing in the riskier natural gas development division and underinvesting in other less risky divisions. If the Exxon were using the divisional WACC model it would properly invest in each division since each division would dictate its own risk and required rate of return.
Assuming that Exxon Mobile went ahead with the divisional method of accounting for costs of capital it would need to further estimate these costs of capital, evaluate the weights to use, and estimate the costs of individual sources of capital for each division. Estimating the divisional costs of capital would require Exxon Mobile to utilize either the discounted cash flow technique or return on investment. The discounted cash flow method is superior to the return on investment method for analyzing capital investment decisions because it incorporates the time value of money (Sinclair, 2010). This would allow...

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