ExxonMobil: Value of Financial Flexibility, question 2.
Dear Aswath, thank you for your previous answer.
Based on your comment, where/how can I introduce the oil price uncertainty in the Kd to calculate the COST of the flexibility vs. its value, found with the call ?
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I would stick with the conventional measure of cost of debt. Flexibility and its effects should have little effect on the interest rate on debt.
OK, we agree on that.
Basically, I have started from your example in Promise and Peril of R.O.
In the Financial Flexibility, you value first the call. Fine.
Then, of course you have to compare it with the cost of not being at the optimal debt ratio --> Optimal Cost of Capital - Current Cost of Capital.
My issue is in evaluating the optimal cost of capital for Exxon. I succeed in evaluating Ke when Debt ratio moves (by adjusting beta). My issue is with Kd. Current Kd is 5%, Ke 6%. Debt ratio is 8%. Interest coverage is is far above 100. Using your debt rating estimation tool, Exxon will always be a AAA... then i dont succeed to evaluate the optimise debt ratio, since Kd remains constant, cost of capital would tend to be Kd and debt ratio 100%.
How to do ? As a summary, this is "how to evaluate optimal debt ratio...and the adapted Kd"