Finance 459 help
➢ Alternatively, EVA (Economic Value Added) = NOPAT – WACC (Invested Capital) can be applied to value the value of investment project.
• Optimal Capital Structure
➢ Midland regularly reevaluated its debt levels and set long-term capital structure accordingly.
➢ Midland’s increasing borrowing capacity will shield additional profits from taxes.
➢ Midland’s target debt ratio is set based on each division’s annual operating cash flow and collateral value of its identifiable assets.
➢ Cost of debt is estimated based on debt rating and spread over T-bonds.
• Stock Repurchase
➢ Midland estimated its intrinsic value by applying DCF method. Share repurchase were processed whenever intrinsic value higher the prevailing stock price.
D. Case Questions (Each Team needs to address the following questions)
• Calculate Midland’s corporate WACC at the prevailing (current) capital structure vs. at target capital structure.
➢ Be prepared to defend your specific assumptions about the various inputs adopted into calculation.
➢ In this case, the team is expected to suggest the proposed market risk premium.
• Compute a separate cost of capital for the E&P, Marketing &Refining and Petrochemicals divisions.
➢ How was cost of debt measured of each division? Should the cost of debt differ across three divisions? Why?
➢ What is/are suitable comparables? Why are they chosen as the comparables?
➢ What cause each divisional WACC to differ from one another?
E. Suggested Models /Methods for Case Questions
• By now, each team should be familiar with WACC formula (refer to Chapter 10)
• Midland’s target debt ratio is different from its actual debt ratio
➢ Table 1 vs. Exhibit #5
➢ Current equity beta (1.25) does not reflect the “true” equity beta at target debt ratio for Midland. How to solve this issue? Hamada Equation
➢ Asset beta (unlevered beta) – reflects business risk in the market in which a firm operates.
➢ Equity beta (levered beta) – considers
• Optimal Capital Structure
➢ Midland regularly reevaluated its debt levels and set long-term capital structure accordingly.
➢ Midland’s increasing borrowing capacity will shield additional profits from taxes.
➢ Midland’s target debt ratio is set based on each division’s annual operating cash flow and collateral value of its identifiable assets.
➢ Cost of debt is estimated based on debt rating and spread over T-bonds.
• Stock Repurchase
➢ Midland estimated its intrinsic value by applying DCF method. Share repurchase were processed whenever intrinsic value higher the prevailing stock price.
D. Case Questions (Each Team needs to address the following questions)
• Calculate Midland’s corporate WACC at the prevailing (current) capital structure vs. at target capital structure.
➢ Be prepared to defend your specific assumptions about the various inputs adopted into calculation.
➢ In this case, the team is expected to suggest the proposed market risk premium.
• Compute a separate cost of capital for the E&P, Marketing &Refining and Petrochemicals divisions.
➢ How was cost of debt measured of each division? Should the cost of debt differ across three divisions? Why?
➢ What is/are suitable comparables? Why are they chosen as the comparables?
➢ What cause each divisional WACC to differ from one another?
E. Suggested Models /Methods for Case Questions
• By now, each team should be familiar with WACC formula (refer to Chapter 10)
• Midland’s target debt ratio is different from its actual debt ratio
➢ Table 1 vs. Exhibit #5
➢ Current equity beta (1.25) does not reflect the “true” equity beta at target debt ratio for Midland. How to solve this issue? Hamada Equation
➢ Asset beta (unlevered beta) – reflects business risk in the market in which a firm operates.
➢ Equity beta (levered beta) – considers