Drilling South: Petrobras Evaluates Pecom Harvard Case Solution & Analysis

INTRODUCTION

Petrobras is the company that mainly deals in oil and at the time it was created, it was considered to be a symbol of Brazil’s natural wealth. Petrobras came into existence in almost 1953. Furthermore, Petrobras was incorporated as a mixed capital company. There was a monopoly in the market in which Petrobras was operating however,it ended almost January 2002. This happened at the time when the prices of crude oil and other products were deregulated on a domestic basis by the government of Brazil.

Moreover, the main aim of petrobras was to make an acquisition of one of the companies,which includes Pecom. These firms were based in Argentina and this would add greater value to the business of Petrobras. The main reason is that both of the companies are operating in the same industry sector. Hence, it will be ultimately related to the diversification approach because of the same nature of the product in which Petrobras operates.

Apart from that, Petrobras had a dominant position mainly in the activities that were both upstream and downstream. Petrobras had a good profile overall and it became a fully integrated oil and gas company by almost 2001. This integration took place approximately over 50 years after Petrobras came into existence. It was also the seventh-largest oil and gas company that was trading publicly.

It also adopted various organizational strategies as per the information available in the case. The upstream activities in which Petrobras was involved include the exploration, the oil production and the development programs. On the other hand, it is operating in very emerging markets and hence, operating in the country whose economy is developing such as Brazil. Furthermore, Petrobras is having a large pool of assets that will prove quite beneficial in the long term success of a company. Apart from that, by making an effective use of these assets, there are greater chances that there is a significant growth in the production phase.

PROBLEM STATEMENT

Petrobras is a Brazilian company that is trying to evaluate the acquisition of a company that is based in Argentina. The acquisition will result in the increase of Petrobras’oil reserves to expand its interests in other countries. This will prove beneficial to the Brazilian company because of its exposure into new market segments. The reason that Pecom is being sold is due to the presence of the financial crisis in Argentina. Moreover, it is trying to acquire the firm thatis operating in the same segment. Hence, there is a need to value the transaction, which will result in the payment for Pecom.

ANALYSIS

WEIGHTED AVERAGE COST OF CAPITAL (WACC)

 As per the calculations, it can be seen that the percentage related to the weighted average cost of capital is lower than the threshold that was set by Petrobras in order to make an acquisition after that cost of capital is exceeded. WACC is normally used to measure the rate of return that is accepted by the investors of the company. There are several sources that include the common stock, bonds, and the preferred stock and there are several other debts that are included in the calculation of WACC.

It is quite clear that when the company is not able to generate sufficient returns for the investments it has made, then the investors are ultimately not going to be satisfied. Therefore, to make any acquisition successful, there is a need to take into account the capital structure of the company that is going to make an acquisition. Hence, in this situation, the debt to equity ratio of almost 38.90% is used to calculate the value of weighted average cost of capital. As per the case, it is mentioned that if the weighted average cost of capital did not exceed 14% WACC, then the project based on the acquisition of Pecom will not be acceptable to the shareholders of Petrobras.

Moreover, the risk-free rate that has been used in the workings is almost equal to 3.75%. Apart from that, the percentage that has been taken as a market risk premium in the capital asset pricing model is approximately equal to 5.50% and it is taken from the data available in the case relatively. Apart from that, the equity beta of 0.87 is also incorporated to calculate a value of weighted average cost of capital............................

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