Midland Energy Resources Inc.: Cost Of Capital

1059 words - 5 pages

Introduction
Midland Energy Resources have a senior vice president, Janet Mortension, of project finance. She was preparing her annual cost of capital for midland as well as for each of its following three divisions:
* Exploration & production (E&P)
* Refining & Marketing (R&M)
* Petrochemicals
Midland was a global company with operations in oil and gas. Midland corporate treasury had began analysis and preparation of annual cost of capital for the corporation as a whole and for each divisions as part of annual capital budgeting process but this estimates were often criticized, and Midland division presidents and controllers sometimes challenged specific ...view middle of the document...

The performance of a division over a given historical period was measured in two ways:
* Performance against plan
* Economic Value Added(EVA)
Optimal capital structure:
Midland Optimized its capital structure in large part by prudently exploiting the borrowing capacity inherent in his energy reserves and in long-lived productive assets such as refining facilities. Debt targets were regularly reevaluated and long term debts sets accordingly. Each division had its own target debt ratio and these targets were set on considerations involving each division’s annual cash flow and the collateral value of its identifiable assets.
Stock Repurchases:
In the past, midland repurchase its own shares on occasion, and had state that it would do so again whenever attractive opportunities arose when the stock price fell below the stock’s intrinsic value, Midland considering repurchasing its share.
Midland’s primarily calculations were based on the WACC.
* Cost of Debt
* Cost of Equity

Cost of Equity:
To calculate the cost of equity, Mortensen used the capital Asset Pricing Model (CAPM). Following is the formula of (CAPM):
How are the Mortensen estimates of midland cost of capital used how if at all should these anticipated uses effect the calculations? 
Midland, including the assets appraisal for capital budgeting and financial accounting, Here are many estimates used to calculate the cost of capital in many analysis within performance assessments, M&A proposals, and stock repurchase decisions. Some of these analysis were performed at the division or business unit level, while others were executed at the corporate level. Midland corporate treasury staff had begun preparing annual cost of capital estimates for the corporation and each division in the early 1980s.
Calculate midland corporate WACC? Be prepared to defined your pacific assumptions about the variance inputs to the calculations is midland choice of EMRP appropriate if not what recommendations would you made & why? 
Ans: WACC= Wd rd (1- T) + We re
Wd =weight of debt, rd=cost of debt
We =weight of equity, re= cost of equity
The WACC of the Midland can be calculated as:
Whereas the input data is:
Wd = 42.2% rd = 6.6% Tax rate = 40% we = 57.8 %
So :
WACC= wd rd (1- T) + we re
= 0.422 (0.066) (1-0.4) + 0.578 (0.1158)
= 0.08364 or 8.36%

Working Note for “Equity Rate”:
re = r f + b (r m)
= 0.0498+1.32 (0.05)
= 0.0498+0.066
= 0.1158 or 11.58%
Working for the debt rate
Rd = Rfr +STT
= 4.98% +1.62%
=6.6%
Working for beta
bu =bL \ 1+ (1-40%) (D\E)
= 1.25.+ (0.6) (0.372 Introduction
Midland Energy Resources have a senior vice president, Janet Mortension, of project finance. She was preparing her annual cost of capital for midland as well as for each of its following three divisions:
* Exploration & production...

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