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Treasury securities of a similar maturity. The spread depended on a variety of factors, including the division’s cash flow from operations, the collateral value of the division’s assets, and overall credit market conditions. For some of Midland’s operations, long-term expected cash flow and collateral value were affected by political risk. This risk was most apparent, for example, in the exploration and production division. A significant fraction of E&P’s productive assets and proven reserves were located in politically volatile countries in which the risk of nationalization or a forced renegotiation of production rights was significant. All else equal, such properties supported less borrowing than might otherwise be
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re = rf + β(EMRP) Mortensen was aware that betas were measured, with error, from regressions of individual stock returns on market returns. She and her team used betas published in commercially available databases, rather than running their own regressions. Midland’s beta was 1.25, for example. However, betas for Midland’s divisions were not observable, since the divisions did not have traded shares of stock. To estimate betas for the divisions, Mortensen relied on published betas for publicly traded companies she deemed comparable to each division’s business. A selection of these, along with related financial data, is presented in Exhibit 5. In 2006 Midland used an equity market risk premium of 5.0%, but higher EMRPs—6.0% to 6.5%— had been used by Midland at various times in the past. Historical data on stock returns and bond yields, such as those presented in Exhibit 6, supported the higher estimates of the EMRP. Other data, such as the survey results shown in Exhibit 6, suggested lower figures. Midland adopted its current estimate of 5.0% after a review of recent research and in consultation with its professional advisors— primarily its bankers and auditors—as well as Wall Street analysts covering the
re = rf + β(EMRP) Mortensen was aware that betas were measured, with error, from regressions of individual stock returns on market returns. She and her team used betas published in commercially available databases, rather than running their own regressions. Midland’s beta was 1.25, for example. However, betas for Midland’s divisions were not observable, since the divisions did not have traded shares of stock. To estimate betas for the divisions, Mortensen relied on published betas for publicly traded companies she deemed comparable to each division’s business. A selection of these, along with related financial data, is presented in Exhibit 5. In 2006 Midland used an equity market risk premium of 5.0%, but higher EMRPs—6.0% to 6.5%— had been used by Midland at various times in the past. Historical data on stock returns and bond yields, such as those presented in Exhibit 6, supported the higher estimates of the EMRP. Other data, such as the survey results shown in Exhibit 6, suggested lower figures. Midland adopted its current estimate of 5.0% after a review of recent research and in consultation with its professional advisors— primarily its bankers and auditors—as well as Wall Street analysts covering the