Homework Question on Cost of Capital
- In 2009, ExxonMobil (XOM) acquired XTO Energy for $ 41 billion. The acquisition provided ExxonMobil an opportunity to engage in the development of shale and unconventional natural gas resources within the continental United States. This acquisition added to ExxonMobil’s existing upstream (exploration and development) activities. In addition to this business segment, ExxonMobil was also engaged in chemicals and downstream operations related to the refining of crude oil into a variety of consumer and industrial products.
- How do you think the company should approach the determination of its cost of capital for making new capital investment decisions?
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Homework Answer on Cost of Capital
Determination of cost of capital for making new capital investment decisions
Cost of capital is the cost a company or organization is required to finance through cash or other means besides settling what a company owes other organizations and individuals in relation to current investments. The cost of capital according to Rosenbaum and Pearl (2009) is used to focus and help arrange for the organization’s viable projects.
For a company to be in a good position to determine its investment then the cost of capital should be able to earn more returns than the investment value itself (Yee, 2000). This is an indicator that the business is ready to initiate other investments implying that the company cannot start an investment when it cannot achieve returns on capital required on investment.
In the case of Exxon Mobil, determination of cost of capital can be through determination of weighted average cost of capital. This company has acquired XTO Energy for $41 billion hence its company’s ability to engage in the development of shale and unconventional natural gas resources within the continental United States in addition to increasing Exxon Mobil’s existing upstream i.e. exploration and development activities. According to Hou, Van Dijk and Zhang (2012), weighted average cost of capital is financially used to determine the cost of capital.