Question

Petrobras’ controlling shareholder is the Brazilian government, not the ADR holder. If Petrobras focuses on maximizing the government’s valuation of the shares, how would this affect its discount rate for Pecom? (I am looking for a qualitative answer here)

Harvard Case: Drilling South: Petrobras Evaluates Pecom

Answer 1

Impact on the discount rate-

• Government share valuation depends on the market price of the common stocks. It will maximize the shareholders wealth. The main goal behind maximizing shares value is to increase the present value of securities. The present value is calculated from sales of common stocks and dividend payments.
• Present value is derived from the discount rate which will affect the returns from the alternative investment options.
• The risk and benefits also depends on the rate of discount, whether it is low, high or moderate. Management decision making will be effective only when the risk factors will get mitigated.
• Discount rate will impact on the fair value of the corporation's equity. Because during budget planning, weighted average cost of capital is calculated by considering the discounted cash flow.
• It will determine the benchmark returns from equities and debt instruments. So that the business will be able to project their short term obligations.
• Hence petrobras must use debt-equity combined financing to maximize the shareholders return from the investment options and it has tax advantages due to interest expenses are tax deductible.