Case Study: Cost of Capital

Presented by:
Aditya Syamsu
Bhagas Arga
Hanif Widyanto
Irreza Irreza
Backstory
• Petroleo Brasileiro S.A (Petrobras) is an integrated oil and
gas company founded in 1954 by the Brazilian Gov’t.
• Listed in Sao Paulo in 1997, and NYSE in 2000 (Gov’t still
the controlling shareholder).

1. December 2001, exchange of operating

Corporate assets with Repsol YPF of Argentina.
Actions 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 “one’s 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