Midland Case

Topics: Risk-free interest rate, United States Department of the Treasury, Weighted average cost of capital Pages: 2 (572 words) Published: February 12, 2013
Midland's cost of capital

1. I choose the rate of 30-year U.S. Treasury bonds in 2007 (4.98%) as the risk free rate in the 2007 WACC calculations. The reason is that majority of large firms and financial analysts report using long-term yields for bonds to determine the risk-free rate. Rf=0.0498 2. Cost of debt, which is determined by adding the spread to Treasury (1.62%) to the rate of 30-year treasury bonds in 2007. Rd=0.0498+0.0162=0.066 3. Cost of equity, the EMRP (5%) and D/E (59.3%) was taken out of the context of the case. βa=Equity Beta/(1+D/E)= 1.25/(1+0.593)= 0.78

According to Table1, consolidated D/V is 42.2%, E/V is 57.8%, βe= βa*(1+D/E)= 0.78*(1+0.422/0.578)=1.35
Re=Rf+ βe *EMRP= 0.0498+(1.35*0.05)= 0.1173
4. WACC, the tax rate (38.58%) was from the 2006 taxes paid. WACC= D/V*(1-T)*Rd+E/V*Re= 0.422*(1-0.3858)*0.066+0.578*0.1173=8.49% The division costs of capital
Exploration & Production
1. I also use of 30-year U.S. Treasury bonds in 2007 (4.98%) as the risk free rate, Rf=0.0498. 2. Cost of debt, Rd=Rf+ the spread to Treasury(Exploration & Production)=0.0498+0.016=0.0658 3. Cost of equity, EMRP=5%. Since we can’t get the beta of E&P, we should use the information of comparable companies on Exhibit 5 to get average asset beta, and then to calculate the beta of E&P. βa=Equity Beta/(1+D/E)= 1.15/(1+0.398)= 0.82

According to Table1, consolidated D/V is 46%, E/V is 54%,
βe= βa*(1+D/E)= 0.82*(1+0.46/0.54)=1.52
Re=Rf+ βe *EMRP= 0.0498+(1.52*0.05)= 0.1258
4. T=38.58%
WACC= D/V*(1-T)*Rd+E/V*Re= 0.46*(1-0.3858)*0.0658+0.56*0.1258=8.9% Refining & Marketing (same with Exploration & Production) 1. Rf=0.0498
2. Cost of debt, Rd=Rf+ the spread to Treasury(Refining & Marketing)=0.0498+0.018=0.0678 3. Cost of equity, EMRP=5%.
βa=Equity Beta/(1+D/E)= 1.2/(1+0.203)= 0.998
According to Table1, consolidated D/V is 31%, E/V is 69%,
βe= βa*(1+D/E)= 0.998*(1+0.31/0.69)=1.45
Re=Rf+ βe *EMRP=...
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