Introduction:
Midland Energy Resources, Inc. is a global energy company with its operations in three divisions – Oil and gas exploration, Refining and Marketing and Petrochemicals. The company has been there for 120 years and in 2007 had more than 80,000 employees. It has been a very profitable company with reported operating revenue of $248.5 billion and operating income of $42.2 billion in 2006. The primary goals of Midland’s financial strategy are to fund overseas growth, invest in value-creating project, achieve an optimal capital strategy and repurchase undervalued shares. To accomplish all these goals the company has asked Janet Mortensen, Vice President of finance for Midland energy resources, to calculate the weighted average cost of capital (WACC) for the company as a whole. Formula: WACC = rd (D/V) (1-t) + re (E/V)

Where, rd = cost of debt; re= cost of equity; D = Market value of debt; E= Market value of equity; V= Market Value of the company (D+E); t= Tax rate. Risk Free Rate, rf: Midland’s borrowing capacity is typically depended on its energy reserves and long-term assets. Considering its assets long-term valuation a 1-year risk free rate seemed unreasonable. Furthermore there is a high correlation of Midland’s stock price with changes in energy prices, which required periodic re-evaluation of its borrowing capacity. A 30-year Treasury bond rate also doesn’t quite seem to justify its unpredictable nature. For Exploration and Production (E&P) and Refining and Marketing (R&M) a 30 year maturity T-Bond can be used as those divisions tended to focus on longer term projects. But a division like Petrochemicals tends to focus on shorter-term projects. So, 1 year T-bond will be applicable for this. So, for overall, Midland Energy Resource we have decided to take 10-year risk free rate, which is 4.66%. Equity Market Risk Premium (EMRP): In 2006, Midland used an equity market risk premium of 5%, but higher EMRP’s -6% to 6.5% - had been used by...

...MidlandEnergyResources, Cost of Capital
The case is about how Janet Mortensen, senior vice president of project finance for MidlandEnergyResources, prepare her annual cost of capital estimates for midland and each of its three divisions for her company. Midland was a global energy company with operations in oil and gas exploration and production (E&P), refining and marketing(R&M), and petrochemicals. Estimates of cost of capital prepared by Mortensen were used in many analyses within Midland, including asset appraisals for both capital budgeting and financial accounting, performance assessments. Since her calculations had been widely applied in various areas and became influential, she was considering appending a sort of user’s guide to the 2007 set of calculations for reference to different applications.
Mortensen used WACC formula to estimate cost of capital, compute the cost of debt by adding a premium over US Treasury securities of a similar maturity, and calculate the cost of equity by using the CAPM formula. After reviewing the case and tables given, we calculated the company’s composite WACC and WACCs for each division respectively. The company’s composite WACC...

...MidlandEnergyResource
Report for Cost of Capital
October 16, 2014
Abstraction
General Analysis of MidlandEnergyResourcesCost of Debt
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Consolidated Company
Exploration & Production
Refining and Marketing
Petrochemicals
Cost of Equity
Equity market risk premium of 5% is reasonable. According to the Exhibit 6, the U.S. stock return minus Treasury bond yields for each period varies. Since each period has different standard
error, it will be better to take the weighted average of the data, then EMRP is approximately
5.9% or lets say 6.0%. Comparing to the EMRP that Midland would use in the calculation of
WACC which is 5%, the historical data reflects a higher EMRP. But from the market risk premium survey results, we see that finance professors, CFOs and fund managers advocate a lower
rate on risk premium. Because these people have better understanding in the performance of the
market and be more aware of how economics works, then the analysis from them should be taken
into great consideration. Therefore, 6.0% from the past data balanced with some lower rates
that suggested by bankers, auditors as well as Wall Street analysts, 5% should be appropriate.
Weighted Average Cost of Capital
WACC = λ(1 − t)KD + (1 − λ)KE
The Effect of Leverage on the...

...MidlandEnergy
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MidlandEnergyResources, 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
MidlandEnergyResources is a globalenergy 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 MidlandEnergyResources 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
MidlandEnergyResources is a leading global energy developer dedicated to providing advanced power systems and energy services around the world. MidlandEnergy...

...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?
The purpose is that the costcapital will be used for capital budgeting, financial accounting, performance assessment, stock repurchases estimations. Also the cost of capital is a necessary basis for the expected growth and forecasted demand.
The too high estimated cost of capital means that Midland may miss out on investment opportunities and will under value the investment at hand. Furthermore, it is possible for shareholders to see a lower return on their investment. On the other hand, a too low estimated cost of capital means that Midland may engage in an investment that is potentially “bad” and will be overvalued. Shareholders will see over inflated returns.
2. Calculate Midland’s firm-wide WACC. Make sure you explain clearly your method and your choice of inputs. In particular, is Midland’s choice of market risk premium appropriate, and if not, what recommendations would you make and why?
Based on our calculations, the Midland’s firm-wide WACC we have got is 8.48%.First, we choose the rate of 30-year U.S. Treasury bonds in 2007 (4.98%) as the risk free rate we use in the...

...Executive Summary: MidlandEnergyResources, Inc. is a global energy company with a broad array of products and services. The company operates within three different operations including oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Midland has proven to be a very profitable company, with reported operating revenue of $248.5 billion and operating income of $42.2 billion. The company has been in business for over 120 years and employed more than 80,000 individuals. Janet Mortensen, the senior vice president of project finance for MidlandEnergyResources, has been asked to calculate the weighted average cost of capital (WACC) for the company as a whole, as well as each of its three divisions as part of an annual budgeting process. Midland’s Three Divisions: Exploration & Production Oil exploration and production (E&P) is Midland’s most profitable business, and its net margin over the previous five years was among the highest in the industry. With oil prices at historic highs in early 2007, Midland anticipated heavy investment in acquisitions of promising properties, in development of its proved undeveloped reserves, and in expanding production. They also needed to account for competition from areas such as the Middle East, Central Asia, Russia, and West Africa. Refining and...

...MidlandEnergyResources
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?
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. Moreover, depending on correct cost of capital, Midland will be able to make accurate financial forecast on supply, demand, and growth, and will decide their new financial and investment decision on a good direction.
On one hand, when Ms Mortensen get a too high estimate compare to the “true” cost of capital, the estimated NPV of new investment will easily become lower than the “true” NPV. According to the wrong estimate on NPV, Midland might miss out many investment opportunities and underestimate the investments.
On the other hand, when getting too low estimate on cost of capital, midland will estimate the new investment with higher NPV. Midland might waste much money on many bad investments which are...

...MidlandEnergyResourcesMidlandEnergyResources is a fully integrated energy company with operations in E&P, Refining & Marketing (R&M) and Petrochemicals. Capital budgeting at Midland is done using discounted cash flow method and weighted average cost of capital (rwacc).
Corporate Weighted Average Cost ofCapital, rwacc
The primary use of the corporate rwacc is valuation (TV=FCF/(rwacc-g)). While the rwacc may be used for evaluating internal projects, the usage will be incorrect owing to the fact that the risk-return profile, debt structure and credit rating of individual projects/departments may be different. Sometimes companies may want to repurchase stock if they think their stock undervalued and to do this valuation cost of capital is required. But this would be a short term valuation and hence the risk free rate of return to be used should be of short term. The corporate rwacc for Midland is 8.55% (refer Ex-1). The following table enumerates the various assumptions:
Assumption Value Remarks
Market risk premium 5.1%
5.1% represents the 200 year average, with the lowest standard error of 1.2%. Moreover this value is between the acceptable range of 4-6%.
Risk free rate of return 4.98%
30 year long term treasury rates have been used for...

...Case Study 2
MidlandEnergyResources (as a whole company)
According to the article, the beta of MidlandEnergy is 1.25. beta=1.25
cost of equity re = rf + beta * (EMRPs)
EMRPs = 5.0%
We assume that the company will run for next 30years, so the rate of risk free is 4.98%
rf = 4.98%
Cost of Equity: rE = rf + beta * (EMRPs) = 4.98% + 1.25 * 5% = 11.23%
Market Value of Equity = $134114m (Exhibit 5)
Cost of Debt 30years, rD = rf + spread to treasury = 4.98% + 1.62% = 6.60%
Market Value of Debt = Market Value of Equity * D/E = 134114 * 73% = 97903m
Tax rate = (41.4% + 39.2% + 38.6%)/3 = 39.72%
WACC30 = rD * (D/V) * (1-t) + rE * (E/V) = 6.60% * 42.2% * (1-39.72%) + 11.23% * 57.8% = 1.68% + 6.49% = 8.17%
E&P, R&M, Petrochemicals calculation
We will assume that all of the three divisions will last for a long-term which is more than 30 years, because E&P division is gaining the highest margin in the industry, R&M division is the company's largest division, and Petrochemicals is expected to grow in the near-term. Following that assumption, we would like to assume the rf is 4.98%. The beta of Petrochemicals division should be calculated as follow:
The equity beta of E&P industry is 1.15 and beta of R&M is 1.20 in 2006. To calculate the equity beta in 2007, I will firstly calculate the assets beta, and then use estimated D/V calculate the new equity...