Introduction
ExxonMobil is a vast corporation specializing in oil, natural gas, and chemical production. ExxonMobil has many subsidiaries under its control that benefit from it every year. Subsidiaries of the company have vast geography: Belgium, Hong Kong, Italy, Egypt, Kazakhstan, Brazil, and many other countries (Pickl, 2019). Professionals must always perform financial analysis and forecasting in such companies; otherwise, the number of lost investments will amount to billions of dollars. Given the scale of ExxonMobil, managers may not justify some of the risks in calculating capital, and financial transactions must be subject to strict rules. ExxonMobil has colossal capital and a complex structure of subsidiaries and divisions: upstream, downstream, chemical, and global services (Streamlining Upstream Organization to Support Growth Plans, 2019). Financial management in an enterprise requires extreme attention and detailed work. At this point, given the experience of high risks, financial analysis suggests that ExxonMobil should not use a single company-wide cost of capital when analyzing capital expenditures across all of its business units. It is better to use the classic CAPM (Capital Asset Pricing Model) to assess and determine the cost of capital.
Single Company-wide Cost
The COVID-19 crisis has shown that various company divisions can conduct themselves in opposite ways under different conditions on the international market. Thus, last year’s only profitable division was the chemical division, while upstream and downstream suffered losses. An energy collapse caused it in the market; COVID-19 demonstrated the rhythms of the stock market as inadequate under strict lockdown conditions. The apparent difference in divisions manifested itself clearly in crisis conditions.
The chemical division proved to be the most stress-resistant and resilient last year; this division generated unexpectedly large profits. These situations show that it is illiquid to use a single cost of capital for all divisions. It is desirable that different divisions not only have unique financial analytics and fixed cost of capital but also have their team of financiers and analysts for each division.
The established cost of capital is directly related to the prospective earnings and expenses of a particular unit and, only later – of the whole company. The company needs a detailed forecast since failures can lead to billions of losses and collapse in the energy market. The unique cost of capital, carefully established by analysts, will help avoid making wrong decisions in the future and work promptly in a crisis (Pickl, 2019). Moreover, considering the possibilities of each division separately, the company will be able to invite more other companies for cooperation and create more projects. These projects will then be aimed not at improving the company’s financial solvency but at bringing income to the division. When making decisions about tasks, managers must always keep track of stock changes. Only then will it be clear whether the company and, more importantly, a specific division will receive long-term profit by working on a particular project.
Thus, using a single company-wide cost of capital for all divisions is considered inadequate and illiquid since the company’s divisions in question have different risk resistance and potential. The unique cost of capital for all divisions will allow managers and analysts to participate in various projects and “make effective decisions” (Wisner et al., 2018, p. 511). Establishing a single cost of capital for all divisions will lead to an underprice assessment of the division’s contribution and specifics. Without taking this into account, it will be impossible to compose analytics and predict losses successfully.
Estimating the Cost of Capital
It is possible to determine the cost of capital from various resources if the cost of investment and the worth of individual projects are known. It is also necessary to assess the risks in implementing projects (Riedl, 2021). A division’s cost of capital is also affected by the ordinary and the privileged. The cost of each capital element is called the specific capital cost. Any company can attract this capital through loans and debt obligations in addition to equity capital. The Capital Asset Pricing Model can account for many complex components of the cost of capital. The CAPM is not calculated for each unit, but it contains information about each team in the formula. CAPM intelligently considers risks and risk-free returns and builds an effective balance of securities and bonds. CAPM assumes the calculation of data for the long term.
The weight for each source of capital is calculated by dividing the market value of the company’s capital by the sum of the market value of debt and equity. The weighted average cost of capital and figuring it is a multifaceted and ambitious task. For this task, it is necessary to study the various capital structures and determine what combination can give the minimum cost of capital; careful selection is required. The Weighted Average Cost of Capital (WACC) is used to assess investment opportunities. The WACC should reflect the estimated costs of the company and its divisions. The information received from the WACC subsequently helps analysts, financiers, and managers decide whether to attract investments to the project. If assets are to be drawn, the WACC will help determine what size they should be.
Thus, CAPM helps to calculate the cost of capital for each division. CAPM competently considers possible risks and fees and assesses the market position in the long term (Streamlining Upstream Organization to Support Growth Plans, 2019). The weight for each capital resource is calculated through a complex selection of capital structures. From the results obtained, it is possible to get the WACC (Weighted Average Cost of Capital), which helps managers and financiers make decisions that are useful in the long term.
Conclusion
It is strongly recommended not to use a single company’s total cost of capital for analytics capital costs. It will lead to incorrect decisions and neglect of some of the specifics of the various departments at ExxonMobil. The divisions of this company have different capital costs and different resilience to risks, as demonstrated by the COVID-19 pandemic when the chemical division became the only profitable division. Only the chemical division was able to function quickly in the face of changes in the energy market. Analyzing and calculating the capital cost for each division is very complex and requires significant effort. It is recommended for work in each division to organize a team of analysts to create independent and unique economic studies simultaneously.
The classic calculation method is CAPM (Capital Asset Pricing Model), which considers the long-term perspective and risks, which is essential in the current unstable situation on the international market as a whole. The weight of each resource is calculated through selection, and search combinations can give the minimum cost of capital. Subsequently, the Weighted Average Cost of Capital (WACC) balance found helps determine which projects should be invested in and which from them can bring long-term benefits.
References
Pickl, M. J. (2019). The renewable energy strategies of oil majors – from oil to energy? Energy Strategy Reviews, 26. Web.
Riedl, D. (2021). The magnitude of energy transition risk embedded in fossil fuel company valuations. Heliyon, 7(11). Web.
Streamlining upstream organization to support growth plans. (2019). ExxonMobil. Web.
Wisner, J. D., Tan, K., & Leong, K. G. (2018). Principles of supply chain management: A balanced approach (5th ed.). Cengage Learning.