Midland Energy Resources Case Study

1765 Words 8 Pages
Register to read the introduction… In other words: ( The two tables in the case are as follows: Table 1 Business Segment Consolidated E&P R&M Petrochemicals Credit Rating A+ A+ BBB AATable 2 Maturity 1-Year 10-Year 30-Year Rate 4.54% 4.66% 4.98% Debt/Value 42.2% 46.0% 31.0% 40.0% Spread to Treasury 1.62% 1.60% 1.80% 1.35% ) ) ( …show more content…
We can find our EMRP number by looking at exhibit 6 in the case: Period 1987-2006 1967-2006 1926-2006 1900-2006 1872-2006 1798-2006 Average excess return US Equities – T-Bonds 6.4% 4.8% 7.1% 6.8% 5.9% 5.1% Standard Error 3.7% 2.6% 2.2% 1.9% 1.6% 1.2%

I will choose to use the average return from the time period of 1798-2006. That is the longest sample size in regards to time, as well as having the lowest standard of error. I will round down to 5% for ease of calculation:
[Midland Energy Case Analysis] Managerial Finance 5

( “re” for Midland= 4.98%+5%*1.25= 11.23% “re” for E&P= 4.98%+5%*1.41= 12.03% “re” for R&M= 4.98%+5%*1.33= 11.63% “re” for Petrochemicals= 4.54%+5%*0.32= 6.14%

)

With this information, we are able to finally calculate the weighted average cost of capital (WACC) for Midland and the 3 divisions of the company. The formula and calculations are as follows: ( )( ) ( )

*D/V are provided in Table 1 for Midland, E&P, R&M, and Petrochemicals. They are 42.2%, 46.0%, 31.0%, 40.0% respectively. WACC-cost of capital we need:

WACC for E&P: ( =8.32% WACC for R&M: ( =9.29% WACC for Petrochemicals: ( =5.10% WACC for Midland: ( =9.17%
[Midland Energy Case Analysis] Managerial Finance 6
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By being in different industries, the companies have different risk exposure and betas, while also having different credit ratings. All of these components will affect a company’s cost of capital differently. Further Analysis: Mortensen’s estimates were used for many things including performance assessments, mergers and acquisition proposals, stock repurchases, asset appraisals, and financial accounting. As stated in the case, cost of capital is a very important component in WACC calculations. These calculations were being used to evaluate at a divisional level as well as at a corporate level as a whole. In my calculations for the case, I solved for both levels. In regards to Midland’s corporate WACC, Mortensen computed the cost of debt for each division by adding a premium (or “spread”) over U.S. Treasury securities with an appropriate maturity depending on the division. For Exploration and Production (E&P), Refining and Marketing (R&M), as well as Midland as a corporation, Mortensen used a 30 year maturity TBond assumption as those divisions tended to focus on longer term projects. She decided on a 1 year T-Bond maturity assumption for Petrochemicals as they tended to focus on shorter term projects. Another assumption was that the tax rate (39.73%) remained constant throughout the case as well as an EMRP of 5%. The EMRP was based on exhibit 6 of

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