Midland Assignment

In: Science

Submitted By evilboy215
Words 815
Pages 4
HW #6: For Tuesday, Oct 19th…
TEAM ASSIGNMENT:
1. Your team has been hired as consultants by Janet Mortensen, senior vice president of Midland Energy Resources, Inc., to advise her on cost of capital matters. Read the “Midland Energy Resources, Inc.: Cost of Capital” case (HBP #4129) handed out in class. This case illustrates how the Capital Asset Pricing Model (CAPM) may be used to estimate the Weighted Average Cost of Capital (WACC) in a corporate setting. Then, working with your team, answer each of the following questions using data provided in the case:
i. Why is Midland concerned about its WACC? How will it use this information? ii. From Table 2, what risk-free rate (rf) would you recommend that Midland use in its cost of debt (rd) and cost of equity (re) calculations? Why? iii. For the consolidated company, what is Midland’s cost of debt (rd)? What is the cost of debt for each of the 3 operating divisions? Discuss why these 4 values differ in terms of their respective credit ratings and the nature of their business operations. iv. From Exhibit 1, what tax rate (t) would you recommend that Midland use in its WACC calculations? Why?
v. Your client has instructed you to use an equity market risk premium (EMRP) of 5%. Does this value seem reasonable? Explain. vi. Using the CAPM method and data from Exhibit 5, what is your estimate of Midland’s consolidated cost of equity (re) at this time? vii. What is Midland’s consolidated after-tax cost of capital (WACC) at this time? viii. Based on data from Exhibit 5, what is the un-levered asset beta for the consolidated company? ix. What would be the consolidated company’s after-tax cost of capital (WACC) if it had no debt in its capital structure?
x. What would be the consolidated company’s cost of equity under its future target capital structure as shown in Table 1? What is the corresponding after-tax WACC for…...

Similar Documents

Midland

...what recommendations would you make and why? A- - rd = 30 years to US debt treasury + Spread to treasury rd = 1.62% + 4.98% = 6.6% - Tax average of 2004, 2005 and 2006 Tax average = 41.4% + 39.2% + 38.6% = 39.7% - From Exhibit 6 the historical data shown on EMRP of nearly 6% whereas as per the surveys conducted by financial analysts and firms indicates EMRP to range between 2.5% to 4.7%; analysts on financial markets have a better understanding of the overall market scenario and are well aware about the performance of various companies so their estimate of 5% seems appropriate. - Based on our Calculations Shown on Excel corporate WACC = 8.53% 3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not? A- Midland should use different hurdle rates per division as it reflects the minimum rate of return required on investment. As per Exhibit 5 the equity Beta for each division (E&P, Refining & Marketing) is different so the riskier the project the higher the hurdle rate. 4. Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another? A- The spread to Treasury is slightly lower for E&P than it is for the corporate level. The WACC for the E&P division is 8.21%. The Refining & Marketing division has a higher beta than E&P at 1.20, and its higher spread to Treasury of 1.80% creates a cost of debt of 6.33% and a......

Words: 368 - Pages: 2

Midland

...Midland Energy Resources, Inc.: Cost of Capital Case Solution Total Words: 1930 Excel Calculations: Return on Debt, T-Bills Return, Yield Spread, Beta, Return on Equity, WACC for Midland, Exploration and Production, Refining and Marketing and Petrochemicals. Abstract: Midland Energy Resources has its operations divided amongst three separate divisions. The divisions have different functions and need separate discount rate to evaluate its projects. The cost of capital is very critical in Midland as it used for many diverse purposes. Therefore, it is important to calculate an accurate cost of capital. The Weighted Average Cost of Capital is used to discount Midland’s cash flows. Cost of debt is comparatively easier to calculate using a ‘bond yield plus risk premium’ approach. The cost of equity is calculated using the Capital Asset Pricing Model (CAPM). In CAPM, the calculation of beta requires significant judgment. Industry data is used to calculate the beta, but such data is not available for one of the divisions where an alternative method is applied. There is also some controversy in using the market risk premium: the historical risk premium for US stocks significantly differs from the risk premium used in the industry. By making certain assumptions about these variables, four separate costs of capital are estimated for Midland and its three divisions. Word Writeup: 1.What should be the cost of capital for Midland operational divisions? ...

Words: 414 - Pages: 2

Midland

...Question 1: A, The risk free rate used to calculate the cost of equity of Midland company is the 30-year yield to maturity for US Treasury Bonds: Rf = 4.98%. The company has long term projects for the future; it’s relevant to use a long-term risk free rate. The equity market risk premium is 5% that the company already used in 2006 and obtained after research and consultation with professionals. On Exhibit 6, the respondents’ risk premium of three surveys showed that the range is about 2% to 5.6% in 2006. Despite the average market risk premium is 6.4%, which is higher than the range on the surveys, the EMRP of 5% that we choose seems to be reasonable compared to other companies. In 2006, the debt over equity ratio is 59.3%: D/E = 59.3% D=59.3%E D+E=1.593E = V  E/V = 1/1.593= 62.8%  D/V = 1-62.8% =37.2%. In the estimates of 2007, D/V = 42.2%  E/V = 1-42.2% = 57.8%. The capital structure of the company in 2006 and 2007 is below: Unlverved beta : Bu= Bl(1+1-TDE) Bu= 1.25(1+1-.39737.2%62.8%)=0.921 Levered beta in 2007:Bl=Bu (1+(1-T)(DE) Bl=0.921 (1+(1-.397)(42.2%57.8%)=1.32 Cost of Equity: Re = Rr + β(EMRP) = 4.98% + 1.32*5% = 11.58% Cost of Debt = Spread to Treasury + US T-Bond rate Based on exhibit 1, we calculate the arithmetic average tax rate over 3 years (2004-2006) to forecast the tax rate in the future: Tax rate = Taxes/Income before taxes = 13741417910+1283032723+1174730447 = 0.397 = 39.7% WACC=Rd 1-TDV+ Re EV ......

Words: 635 - Pages: 3

Midland

...Midland was a global energy company with operations in * oil and gas exploration and production (E&P) * refining and marketing (R&M) * and petrochemicals. On a consolidated basis 2006 operating revenue and operating income: $248.5 billion and $42.2 billion Problem: some of these analyses were performed at the division or business unit level, while others were executed at the corporate level. Midland’s corporate treasury staff had begun preparing annual cost of capital estimates for the corporation and each division in the early 1980s. The estimates produced by treasury were often criticized, and Midland’s division presidents and controllers sometimes challenged specific assumptions and inputs. Operations: Midland Energy Resources had been incorporated more than 120 years previously and in 2007 had more than 80,000 employees. Divisions: Exploration and Production: During 2006, Midland extracted approximately 2.10 million barrels of oil per day—a 6.3% increase over 2005 production—and roughly 7.28 billion cubic feet of natural gas per day—an increase of slightly less than 1% over 2005. This represented $22.4 billion of revenue and after-tax earnings of $12.6 billion. **Most profitable part of the business** **Net margin in the last 5 years was amongst the highest in the industry Capital spending in E&P was expected to exceed $8 billion in 2007 and 2008. Refining and Marketing: * ownership interests in 40 refineries around the......

Words: 643 - Pages: 3

Midland

...1. To make an estimate of the cost of capital of Midland Energy Resources, Inc. It will use this information for asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. 2. 4.98% (30 year) would be the best risk-free rate for Midland since refining and marketing is the largest division in the company and refining and marketing division’s projects are mostly long-term projects. 3. Consolidated: 4.98 + 1.62 = 6.60% E&P : 4.98 + 1.60 = 6.58% R&M : 4.98 + 1.80 = 6.78% Petrochemicals: 4.98 + 1.35 = 6.33% Each division has different business operations which has different risks. 4. 40% ([Taxes] / [Income Before Taxes]*100) 5. Yes. Average excess return on US equities to T-bonds shows 5.1% from 1998-2006. Additionally, two empirical values for EMRP averages out to 5% range. 6. 4.98% + 5% * 1.25 = 11.24% 7. = (59.3/159.3)*0.066*(1-0.4) + 100/159.3 * 0.1124 = 8.53% 8. (Unlevered asset beta) = = (100/159.3) * 1.25 = 0.78 9. (WACC with no debt) = (100/159.3) * K_e = 100/159.3 * (0.0498 + 0.78*0.05) = 5.57% 10. (re-levered equity beta) = 1/(1-(42.2/142.2)) * 0.78 = 1.11 (Cost of equity) = 0.0498+0.05*1.11 = 10.53% = 42.2/142.2 * 0.066 * (1-0.4) + (100/142.2) * 0.1053 = 8.58% Since WACC increased in new D/E ratio, firm’s investment choice’s return rate must be higher......

Words: 283 - Pages: 2

Midland

...Question 1: A, The risk free rate used to calculate the cost of equity of Midland company is the 30-year yield to maturity for US Treasury Bonds: Rf = 4.98%. The company has long term projects for the future; it’s relevant to use a long-term risk free rate. The equity market risk premium is 5% that the company already used in 2006 and obtained after research and consultation with professionals. On Exhibit 6, the respondents’ risk premium of three surveys showed that the range is about 2% to 5.6% in 2006. Despite the average market risk premium is 6.4%, which is higher than the range on the surveys, the EMRP of 5% that we choose seems to be reasonable compared to other companies. D=59.3%E(In 2006, the debt over equity ratio is 59.3%: D/E = 59.3% D/V = 1-62.8% =37.2%.( E/V = 1/1.593= 62.8% (D+E=1.593E = V ( E/V = 1-42.2% = 57.8%.(In the estimates of 2007, D/V = 42.2% The capital structure of the company in 2006 and 2007 is below: Unlverved beta : Bu= Bl(1+1-TDE) Bu= 1.25(1+1-.39737.2%62.8%)=0.921 Levered beta in 2007:Bl=Bu (1+(1-T)(DE) Bl=0.921 (1+(1-.397)(42.2%57.8%)=1.32 Cost of Equity: Re = Rr + β(EMRP) = 4.98% + 1.32*5% = 11.58% Cost of Debt = Spread to Treasury + US T-Bond rate Based on exhibit 1, we calculate the arithmetic average tax rate over 3 years (2004-2006) to forecast the tax rate in the future: Tax rate = Taxes/Income before taxes = 13741417910+1283032723+1174730447 = 0.397 = 39.7% WACC=Rd 1-TDV+ Re EV WACC=0.066 1-.39742.2%+ 0.1158......

Words: 393 - Pages: 2

Midland Energy

...QUESTIONS FOR THE OVERALL ASSIGNMENT 1. What is the best way to estimate the company and divisions’ cost of capital? Answer: The best way to estimate the cost of capital is by using the CAPM (Capital Asset Pricing Model) where the Weighted-Average Cost of Capital (rwacc) is given by the formula [pic] Where, D is the market value of the net debt E is the market value of the total equity V is the total market value of debt and equity = D + E T is the corporate tax rate rd is the appropriately calculated discount rate for debt (cost of debt) re is the appropriately calculated discount rate for equity (cost of equity) The cost of capital (rwacc) for the company can be calculated from the observable market values of debt (D), equity (E), & corporate tax rate (T) and calculated discount rate for debt (rd) & discount rate for equity (re). The market values of debt can be estimated from the company’s current amount of debt, their maturity levels, and credit rating and by utilizing the risk-free rate that can be observed in the market. The market value of equity can be estimated from multiplying the total number of outstanding shares and the company’s stock-price. The discount rate for debt can be calculated from on market value of debt and credit rating for the company’s debt, which includes adjustments for the company debt’s default risk. The discount rate for equity can be calculated from......

Words: 1647 - Pages: 7

Midland Energy

...[pic] Midland Energy Resources, Inc. Cost of Capital Table of Contents I. Executive Summary II. Introduction III. Cost of Capital IV. Risk & Tax Rate V. Capital Structures VI. WACC VII. Conclusion VIII. References I. Executive Summary Midland Energy Resources is a global energy company with operations in oil and gas exploration and production(E&P) providing a broad array of products and services to upstream oil and gas customers worldwide including refining and marketing (R&M), natural gas, and petrochemicals. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources must determine the weighted average cost of capital (WACC) for the company as a whole and each of its divisions as part of the annual capital budgeting process. Various considerations have to be evaluated as risk factors when calculating the cost-of capital. II. Introduction Midland Energy Resources is a leading global energy developer dedicated to providing advanced power systems and energy services around the world. Midland Energy Resources has three divisions Exploration & Production, Refining & Marketing, and Petrochemicals. They have been incorporated more than 120 years previously and they have 80,000 employees in 2007. Exploration & Production business include oil and natural gas exploration and field development and production is there most profitable business with the highest net......

Words: 1216 - Pages: 5

Midland

...4129 JUNE 19, 2009 TIMOTHY A. LUEHRMAN JOEL L. HEILPRIN Midland Energy Resources, Inc.: Cost of Capital In late January 2007, Janet Mortensen, senior vice president of project finance for Midland Energy Resources, was preparing her annual cost of capital estimates for Midland and each of its three divisions. Midland was a global energy company with operations in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. On a consolidated basis, the firm had 2006 operating revenue and operating income of $248.5 billion and $42.2 billion, respectively. Estimates of the cost of capital were used in many analyses within Midland, including asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. Some of these analyses were performed at the division or business unit level, while others were executed at the corporate level. Midland’s corporate treasury staff had begun preparing annual cost of capital estimates for the corporation and each division in the early 1980s. The estimates produced by treasury were often criticized, and Midland’s division presidents and controllers sometimes challenged specific assumptions and inputs. In 2002, Mortensen, then a senior analyst reporting to the CFO, was asked to estimate Midland’s cost of capital in connection with a large proposed share repurchase. Six months later she was asked to calculate corporate and......

Words: 4187 - Pages: 17

Midland

...QUESTIONS FOR THE OVERALL ASSIGNMENT 1. What is the best way to estimate the company and divisions’ cost of capital? Answer: The best way to estimate the cost of capital is by using the CAPM (Capital Asset Pricing Model) where the Weighted-Average Cost of Capital (rwacc) is given by the formula Where, D is the market value of the net debt E is the market value of the total equity V is the total market value of debt and equity = D + E T is the corporate tax rate rd is the appropriately calculated discount rate for debt (cost of debt) re is the appropriately calculated discount rate for equity (cost of equity) The cost of capital (rwacc) for the company can be calculated from the observable market values of debt (D), equity (E), & corporate tax rate (T) and calculated discount rate for debt (rd) & discount rate for equity (re). The market values of debt can be estimated from the company’s current amount of debt, their maturity levels, and credit rating and by utilizing the risk-free rate that can be observed in the market. The market value of equity can be estimated from multiplying the total number of outstanding shares and the company’s stock-price. The discount rate for debt can be calculated from on market value of debt and credit rating for the company’s debt, which includes adjustments for the company debt’s default risk. The discount rate for equity can be calculated from estimated values for the equity market risk premium (EMRP) and risk level......

Words: 1628 - Pages: 7

Midland Review

...Midland Energy Resources, Inc.: Cost of Capital Case Objectives This case gives you a chance to apply our ideas about cost of capital (WACC) to a real firm with separate divisions. Assignment You are a team of Finance Professionals with experience in analyzing the cost of capital for divisions of companies and companies overall. Janet Mortensen has been struggling with her calculations, wondering if her application is correct given the amount of grumbling she has heard. She has asked you, as experienced professionals, to analyze the company and the current economic data and to assess the cost of capital for the company and one of the company’s divisions. Ultimately, she wants to be able to answer to her company and staff: RAVI 1) What is the best way to estimate the company and divisions’ cost of capital? COST OF CAPITAL 2) Should it be calculated differently for different purposes?COST OF CAPITAL JAKE WILL COMPILE – everyone will send word write-up for their questions You should address your analysis to Ms. Mortensen and support your analysis for the cost of capital for the company and its divisions. WORD DOCUMENT I will play the role of Ms. Mortensen in assessing your analysis. The class members not presenting will play the role of interested staff, employees and board members. Questions to specifically address 1) KARI What is the appropriate risk-free rate to......

Words: 727 - Pages: 3

Midland

...Study Questions: Midland Energy Resources, Inc: Cost of Capital Janet Mortensen, senior vice president of project finance at Midland Energy Resources, is in the process of preparing her annual cost of capital estimates for Midland and each of its three divisions (oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals). These estimates are used in many analyses within Midland, including capital budgeting decisions, financial accounting, performance appraisals, M&A proposals, and stock repurchase decisions. There has been some disagreement in the past about specific inputs and assumptions used to arrive at the cost of capital estimate, so Mortensen needs to devote extra care in preparing the cost of capital estimates and justifying her assumptions. These questions relate to the Midland Energy Resources, Inc: Cost of Capital case. You can find the data for this case on the course website in a spreadsheet named: Midland Energy Resources Exhibits.xls. 1. For what purposes does Mortensen estimate Midland’s cost of capital? What would be the potential consequences of a too high estimate compared to the firm’s “true” cost of capital? What about a too low estimate? Mortensen estimates Midland’s cost of capital to use for other analyses within Midland such as capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. If the cost of capital is too high, Midland could miss......

Words: 532 - Pages: 3

Midland

...财务管理案例一翻译稿 Midland Energy Resources, Inc.: Cost of Capital 2007年1月下旬,负责Midland能源项目融资的高级副总裁,Mortensen,正在编制Midland及其三个主要业务部门的年度资金成本估算报告。Midland是一个全球性的能源公司,其主要业务为石油和天然气勘探生产(E&P),炼油与销售(R&M),以及石化业务。综合起来看,该公司2006年营业额和营业收益分别为248.5亿美元和42.2亿美元。 在Midland内部,很多的分析需要用到资金成本估评,包括:资本预算和财务核算,绩效评估,M&A 提案,以及股票回购的决定。这些分析有些是在部门或业务单位层面来完成的,有些是在公司层面来完成的。早在20世纪80年代初,Midland的企业财务人员就已经开始为公司以及各部门编制年度资金成本估算。然而,由财务人员编制的估算却常受到批评,公司的各部门领导有时会对特定的假设以及使用的数据提出质疑。 2002年,Mortensen,一位直接受命于CFO的资深分析师,被指派去完成Midland公司股票回购资金成本的估评。半年后,她被指派去计算公司和各部门资本的成本,旨在将公司高层执行机构和赔偿委员会一并纳入计划绩效评估。从那时起,Mortensen便每年开展类似的工作,只要是她做出的估评,即便是公司没有正式要求过的估评,就会成为广泛认可的公司标准。2007年,Mortensen意识到她的报告已成为公司权威,便倾注了更多的精力,精心准备。最近,她在思考,这些估算是否适用于所有的场合,因此,她在考虑对2007年的各种计算增设一套类似于“使用者指南”的文件。 Midland的业务 Midland已经开门做生意120多年了,截止2007年,公司共计80000雇员, Exhibits 1 and 2是Midland的综合财务报表,Exhibit 3是公司2004年至2006年的选定业务分部数据。 勘探与生产 Midland从事勘探,开发和生产各个阶段的业务,然而,生产却是E&P部门的年度经营业绩报告的主体。在 2006年期间,Midland每天大约开采2.1 millon桶油,较2005增长6.3%,每天生产大约7.28 billion立方英尺天然气,相比2005年,增长率略低于1%。这些生产为公司带来22.4 billion美元的营收和12.6 billion美元的税后盈利。 E&P是Midland最赚钱的业务,其在过去五年的净利率达到业界最高水平。 Midland预测全球人口和经济将继续增长,未来全球对其产品的需求将进一步上升。不过,来自于非传统领域的产品,如深水钻井,稠油开采,液化天然气(LNG),以及极地开采技术预计是增长的一部分。此外,产品出产地的地理结构也在发生偏移,如中东,中亚,俄罗斯,西非地区的出产地呈增加趋势。 07年,油价达到历史性的高位,Midland加大了对未开发的新兴资源储备的投资以扩大生产。持续走高的价格,刺激了其对精细开采技术的投资,这些技术能延展现存油田和海洋资源的生命期。07和08年,公司在E&P部门的投资预计将超过$8 billion。 炼油与销售 Midland在全球拥有40个炼油厂,炼化能力达5.0 million 桶/天,如果以营业收入来衡量的话,炼油与销售在其全球营收上占据大笔江山。2006,炼油与销售的营收为$ 203......

Words: 396 - Pages: 2

Midland

...Executive Summary Midland Energy Resources is a leading global energy developer dedicated to providing advanced power systems and energy services around the world. Midland Energy Resources has three divisions Exploration & Production, Refining & Marketing, and Petrochemicals. They have been incorporated more than 120 years previously and they have 80,000 employees in 2007. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources must determine the weighted average cost of capital (WACC) for the company as a whole and each of its divisions as part of the annual capital budgeting process. As each division has different functions and risk associations, the company needs separate discount rate to evaluate its projects. This report is prepared to find out the realistic measures for assessing cost of capital for Midland Energy Resources. After careful evaluation of available information and using finance literature and relevant course lectures, the analysis is prepared to offer appropriate recommendations for Midland Energy Resources to make future capital budgeting decisions. Company Overview Midland Energy Resources is a global energy company with operations in oil and gas exploration and production (E&P) providing a broad array of products and services to upstream oil and gas customers worldwide including refining and marketing (R&M), natural gas, and petrochemicals. Exploration & Production business, including oil and...

Words: 1886 - Pages: 8

Midland

...11). Midland’s choice of EMRP is not appropriate because market risk premium should be estimated individually for each division. Different divisions will have different and unique factors affecting risk, so using one EMRP for all divisions might result in under estimation for some of the divisions and over estimation of EMRP for others. This implies an increase in standard error and deviation from the correct estimation. 3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why of why not? Midland should not rely on a single corporate hurdle rate for evaluating investment opportunities across all divisions because each division is subject to fundamentally different forces such as political volatility, and high future expenditures. For example, R&E is expected to have capital expenditures in excess of $8 billion over the years 2007 and 2008 while worldwide refining capabilities are expected to decrease leading to possible investments in this division of Midland. The Exploration and Production division faces an entirely different set of challenges as oil reserves become more difficult to reach as in the case of arctic and deep water drilling operations, and consequently more expensive to exploit. In addition, political instability has become increasingly prevalent in investment considerations as oil production in areas such as the Middle East and Africa have grown. Civil and political upheaval......

Words: 688 - Pages: 3

Mr. Selfridge | Watch movie | Communication Theory - 3244 Words