Midland Resources Cost Of Capital Essay

896 words - 4 pages

1. Calculation of WACC of a Multi-Division Corporation
2. Sources of Data and their limitation
3. Use of CAPM, Cost of Equity, Effect of Leverage on the Ce, WACC
4. Use of data for comparable to estimate asset betas for division-specific cost of capital
5. Biases and Limitations

No financial modeling.
In the previous years they would include WACC as part of case study 3 – Now it has been changed to 2 – without any actual financial statements. No excel modeling. Focused on how to address the issues.

Multi-Divisional Comapnies
Discount Rate, based on the U.S. The company has three divisions. The profit making divisions, marketing… blah, blah. Very different with each other in ...view middle of the document...

• Many maturities: One that matches a maturity which matches the cash flow that we are discounting.
• Indefinite = 30 year bond – Perpetuity = 10/30 Year Bond

Beta: Three methods to calculate it

• Regression analysis – internet data
• Date
• DRI Adjusted Close
• DJJ Adjusted Close - Proxy
• 3 Month Treasury Bond Yield (Current-Previous)/Previous
• Stock Return
• Index Return
• Monthly Return
• Mothly Bond = Bond rate/1200
o Work out the covariance (ri-rf, rm-rf) = COVAR
o Variance = VAR
o Beta = VAR/COVAR
o Adjusted Beta = Using Historical data to predict the future

Beta is likely to be leveraged - so it has debt impounded into the Beta, since we are working on CAPM - looking at cost of equity only!

Different capital structure - different ratios - to get rid of that variable, need to obtain the equity ratios of that company where that beta was worked out for, put into excel, apply the unlevered beta formula,

Why is the unlevered beta lower than levered beta: Beta is a direct presentation of risk, disregarding the debt component, without debt there is no risk, no interest payments, the more leverage you have, the more risk. We look at beta with CAPM - in equity's point of view. With debt there is more risk, no debt, less risl. Get rid of the debt effect on the beta. The more debt, the larger the effect is.

Now that we have the unlevered beta and averaged it, now you're trying to reflect your own company's capital structure, either have historical, or Target/Optimal...

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