Petrobras Case Summary

1) Why do you think Petrobras’ cost of capital is so high? Are there better ways, or other ways, of calculating its weighted average cost of capital?

Petrobras has high cost of capital because of several factors such as lack of international diversification, they only being listed publicly in Sao Paulo in 1997 and on the New York Stock Exchange (NYSE: PBR) in 2000. They seem to only focus on domestic market rather than internationally. Furthermore, they have high sovereign spread which means they have higher different in the yield compared against the US Treasury. Brazilian government had to pay higher additional yield of dollar funds to the global market as compared to lower paid made up by US Treasury. The higher the yields give greater risk to the investor and US Treasury have better sovereign and creditworthiness rating compared to Brazil that have political stability and economic growth problem. The better ways to calculate the weighted average cost of capital is by diversify the business and market international to reduce the risk as well as reducing the capital cost. Next, try to reduce the weighted average of capital (WACC) by changing the composition of the debt and equity capital on the cost structure by the reducing the amount of them and being alert with the volatility happen in sales and

operating income of the business.

2) Does this method of using the sovereign spread also compensate for currency risk?
Sovereign spread is the differences between the yield on a US Treasury and other government (Brazil government).

In this case, the sovereign spread is compensating for currency risk. There have similarities of characteristics between currency risk and country risk. Basically, currency risk is risk arises due to the changes in exchange rate while country risk is risk that arise when investing in a foreign country. The higher the sovereign spread means the higher the demand for the dollar to balance the yield. The share price is correlated with the sovereign spread so the investor must calculate the weighted average cost of capital that reflects the currency

risks.

3) The final quote on “one’s view on the direction of the broad Brazilian market” suggest that potential investors consider the relative attractiveness of Brazil in their investment decision. How does this perception show up in the calculation of the company’s cost of capital?
The domestic base portfolio of Brazil has increased the Petrobras’ Beta (β) that also will increase the value of ke and weighted average cost of capital. The cost of capital of Petrobras will be higher if the investors uses the base of global portfolio of NYSE. The investor will consider and make decision whether to invest or not in the country base on the difference calculated in the WACC.
The calculation of weighted average cost of capital (kWACC) and cost of equity (ke):
kWACC = keE + kd(1-t)D
V V

ke = krf + βj(km – krf)

The cost of equity is calculating by using the Capital Asset Pricing Model (CAPM).

4) Is the cost capital really a relevant factor in the competitiveness and strategy of a company like Petrobras? Does the corporate cost of capital really affect competitiveness?
Yes, the cost of capital is considering as a relevant factor in the competitiveness and strategy for the companies because it is the rate of return that the company could earned from making the investment. The higher the cost of capital, the higher the required rate of return on investment. Petrobras is doing business related to oil and gas that the selling price is being determined by the global market. Petrobras need to compete with the competitor of the same industry that have lower cost of capital compared to them. So, it will disadvantage for them to compete with having the higher cost of capital because it can reduce the profit margin of the company.