First of all, thank you for your great blog. It is really interesting for learning and even for the ones thinking of doing research.
Purpose: Calculate the Value of Financial flexibility of ExxonMobil
ExxonMobil has a really low (book) debt ratio (8%), which is much lower than the industry average and main competitors (around 20-25%). Therefore it can be interesting to understand why.
- Average Investment needs in % of firm value can easily be found
- Average Internal funding capacity in % of form value can easily be found as well.
==> the value of the option can
Stacey Warren - Expert brainly.com
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be computed more or less easily.
Issue: Comparing this value to the cost of flexibility
- Cost of debt for Exxon seems really low. Cost of equity is low but above.
- By moving the debt ratio to the extreme, the cost of debt does not seem to increase since the EBIT is so huge that it can cover even a 100% debt ratio
- Conclusion is that Exxon should have 100%
Where is the mistake?
* should have 100% debt ratio
You are assuming that oil prices will always be $ 100 a barrel or higher.. The uncertainty here is in what the price of oil will or may be in the future... And as oil prices drop, the EBIT will drop as well.
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Thank you for your comment.
I understand that this uncertainty has to be integrated. BUT should this risk already be included in the current long term Kd for Exxon?
I would guess that is is somehow reflected in their spread...
If not, what would be your approach to evaluate their cost of flexibility, vs. the call calculated before?