Midland Energy Resources has three separate divisions, divided as per their maps. These divisions use different price reduction rates to measure their undertakings. The cost of capital is really of import in Midland as it is used for several intents. WACC is used to dismiss the hard currency flows of Midland. Cost of debt is calculated utilizing a ‘bond yield+ hazard premium ‘ attack whereas the cost of equity is calculated utilizing the CAPM theoretical account. Beta computation in the CAPM theoretical account requires careful analysis. Industry informations can be used wherever it is available and alternate method is used when it is non available.
How are Mortensen ‘s estimations of Midland ‘s cost of capital used? How, if at all, should these awaited utilizations affect the computations?
Mortensen ‘s estimation of Midland ‘s cost of capital usage:
1. EMRP value of 5 %
2. Cost of debt: Output to Maturity ( YTM ) of exchequer securities of similar adulthood + spread to treasury
3. Equity Beta
4. Target D/V after audience among division, executives and board members
These estimations are used for assorted intents runing from public presentation rating to stock redemption.
These estimations affect the computations as follows:
1 EMRP values differ among historical informations figures and assorted analysts.
2 Spread to treasury might non be evaluated decently.
3 Undertakings are in assorted states. Therefore, spread to exchequer may non be the right manner to account for hazard associated.
4 Country hazard premium should besides be added.
5 Beta may alter across the divisions depending upon the type of concern, runing purchase, and fiscal purchase.
Calculate Midland ‘s corporate WACC. Defend your specific premises about the assorted inputs to the computations. Is Midland ‘s pick of EMRP allow? If non, what recommendations would you do and why?
Particulars
Value
Unit of measurements
Premises
Average Stock Price for MIDLAND
$ 42.31
A
A
Average no. of Shares Outstanding
2951
million
A
Net Debt, D
$ 79,508
million
A
Tax rate
38.58 %
A
Using 2006: Effective Tax Rate
Equity beta
1.25
A
A
Equity market hazard premium
5 %
A
A
Calculation
Avg. Market value of Equity, E
$ 124,857
million
A
V = D+E
$ 204,365
million
A
D/E
0.63679346
A
A
D/V ( Actual )
0.38904937
A
A
D/V ( Target ; for twelvemonth 2007 )
42.20 %
A
A
Spread to Treasury
1.62 %
A
A
Output to Maturity _ 1 twelvemonth
4.54 %
A
A
Output to Maturity _ 10 twelvemonth
4.66 %
A
A
Output to Maturity _ 30 twelvemonth
4.98 %
A
A
A
A
A
A
Cost of Debt
6.4400 %
A
50 % of Long term debt has adulthood period 10 old ages and 50 % falls in the scope of 30 %
Cost of Equity ( CAPM )
10.7900 %
A
1 twelvemonth bond YTM: Risk free rate
WACC
7.91 %
A
A
Midland ‘s pick of EMRP may non be appropriate as historical informations on stock returns and bond outputs supports the higher estimations of the EMRP. Other informations, such as study consequences suggest lower figures.
Recommendation:
Midland should utilize scope of EMRP values to cipher a scope of WACC and should utilize the upper, lower and most likely EMRP values to dismiss hard currency flows.
Should Midland utilize a individual corporate hurdle rate for measuring investing chances in all of its divisions? Why or why non?
Midland should non utilize a individual hurdle rate for measuring investing chances in all of its division.
The grounds for this are:
Beta depends on three factors
a ) Type of concern
B ) Operating Leverage
degree Celsius ) Financial purchase
As these three divisions are non precisely in the same concern and are holding differential hazard, hence beta will non be same
Second, Operating purchase will non be same across the three divisions. Exploration and Production will hold more fixed costs incurred because of its type of concern
It will besides hold more uncertainness over the consequences of its undertakings. Therefore more the rise, higher will be the beta values.
Country hazard premium has non been considered in the hurdle rate appraisal. The undertakings being done in states where political and economic scenario is volatile should hold higher WACC taking state hazard premium into history
Discrepancy in computation of Cost of Debt: The adulthood value of debt raised might non be same for every concern section. Therefore, Yield to Maturity of exchequer bonds should non be taken equal, which finally affects the cost of debt.
Calculate a separate cost of capital for the E & A ; P and Marketing & A ; Refining divisions. What causes them to differ from one another?
Exploration and Production
A
Equity Market Value
Net Debt
D/E
Equity Beta
LTM Revenue
LTM Net incomes
Jackson energy
57931
6480
11.20 %
0.89
18512
4981
Wide Plain Petroleum
46089
39375
85.40 %
1.21
17827
8495
Corsicana Energy Corp.
42262
6442
15.20 %
1.11
14505
4467
Worthington Petroleum
27591
13098
47.50 %
1.39
12820
3506
Average Value
A
A
39.83 %
1.15
A
A
WACC Calculation for Midland- E & A ; P Division
Particulars
Value
Unit of measurements
Premises
Effective Tax rate for all the houses
40 %
A
Assuming it to be 40 %
Avg. Debt to Equity ratio of Firms
39.83 %
A
Average: Deliberate
Average Beta_all houses
1.15
A
Equal Weighted Average
Debt/ Value _Target for E & A ; P
46 %
A
Target as given in Table 1
Fringy Tax rate of Midland E & A ; P
38.58 %
A
Taken for Year 2006
Spread to Treasury
1.60 %
A
Given in the Table 1
Calculation
Unlevered Beta _ Midland E & A ; P
0.9282
A
A
D/E_ Target for E & A ; P
85.19 %
A
A
Levered Beta
1.41
A
A
Cost of Equity_CAPM
11.61 %
A
A
Cost of Debt
6.4200 %
A
A
WACC
8.0828 %
A
A
Refining and Selling
A
Equity Market Value
Net Debt
D/E
Equity Beta
LTM Revenue
LTM Net incomes
Bexar Energy Inc.
60356
6200
10.30 %
1.7
160708
9560
Kirk Corp.
15567
3017
19.40 %
0.94
67751
1713
White Point Energy
9204
1925
20.90 %
1.78
31682
1402
Petrarch Fuel Services
2460
-296
-12.00 %
0.24
18874
112
Arkana Petroleum Corp.
18363
5931
32.30 %
1.25
49117
3353
Beaumont Energy Inc
32662
6743
20.60 %
1.04
59989
1467
Dameron Fuel Services
48796
24525
50.30 %
1.42
58750
4646
Average
A
A
20.26 %
1.196
A
A
WACC Calculation for Midland- Refining and Marketing Division
Particulars
Value
Unit of measurements
Premises
Effective Tax rate for all the houses
40 %
A
Assuming it to be 40 %
Avg. Debt to Equity ratio of Firms
20.26 %
A
Average: Deliberate
Average Beta_all houses
1.196
A
Equal Weighted Average
Debt/ Value _Target for E & A ; P
31 %
A
Target as given in Table 1
Fringy Tax rate of Midland E & A ; P
38.58 %
A
Taken for Year 2006
Spread to Treasury
1.80 %
A
Given in the Table 1
Calculation
Unlevered Beta _ Midland E & A ; P
1.0661
A
A
D/E_ Target for E & A ; P
44.93 %
A
A
Levered Beta
1.36
A
A
Cost of Equity_CAPM
11.34 %
A
EMPR assumed to be 5 %
Cost of Debt
6.6200 %
A
A
WACC
9.0862 %
A
A
Reasons for different WACC
Cost of Capital of both the division differs because of different debt to equity ratio of both the houses and different equity beta. We are utilizing comparable method to calculate cost of capital for both the divisions and the difference in both for other comparables houses lead to different values.
One more ground is different debt to equity ratio of both the divisions. Besides for calculation of cost of debt, spread to exchequer is different.
How would you calculate a cost of capital for the Petrochemical division?
Equity Beta Midland
1.25
Equity Beta_ E & A ; P
1.41
Equity Beta_Ref
1.36
Operating Revenue_E & A ; P
22357
Operating Revenue_Ref.
202971
Operating Revenue_Petro
23189
Spread to Treasury
1.35 %
Fringy Tax Rate
38.58 %
Debt/Value ( D/V )
40 %
EMRP
5 %
RFR
4.54 %
Calculation
Weight of E & A ; P
0.09
Weight of Ref.
0.82
Weight of Petro
0.09
Equity beta of Petro
0.132921644
Cost of Equity_CAPM
5.20 %
D/E
66.67 %
Cost of Debt
6.17 %
WACC
4.64 %
