Midland
Midland Energy Resources, Inc.: Cost of Capital
Situation Analysis
Company is trying to estimate cost of capital for each of the three divisions, Exploration and Production (E&P), Refining and Marketing (R&M) and Petrochemicals. Cost of capital analysis is used in taking following decisions in the organization:
Project appraisal
Financial accounting
Stock repurchases decisions
Merger & Acquisitions
Performance assessment
The estimates produced by treasury were criticized because of specific assumptions and inputs were challenged.
Options
There are two options before us just go with the cost of capital provided by treasury or revisit the assumptions and inputs and recalculate the cost of capital for specific divisions. decision While calculating D/E ratio we have added long term debt and current portion of long term debt and subtracted by cash and cash equivalent
We have calculated BV(Debt) and taken proxy for MV(Debt), for equity we have considered market value
Keeping going concern of company in mind we have taken 30-year treasury yield value in calculation
Taking cost of capital of company as hurdle rate will not be optimal because riskiness of projects from different divisions are different hence we need to calculate cost of capital separately for every division
Then based on Target D/E we have unlevered and levered the Beta value to arrive at new Beta which is aligned to Target D/E
Beta consolidated 1.37
Exploration and Production
1.55
Refining and Marketing
1.40
For calculating cost of capital for each division we have taken the Beta for each division and after levering and unlevering we have taken average to arrive at Beta for particular division and calculated cost of capital
Beta of Petrochemical business
β consolidated = sum of weighted average of assets of beta of all divisions
β petrochemicals
0.362
Sensitivity Test
Exploration and Production Refining & Marketing
D/E
WACC D/E
WACC
0%
9.18%
0%
Situation Analysis
Company is trying to estimate cost of capital for each of the three divisions, Exploration and Production (E&P), Refining and Marketing (R&M) and Petrochemicals. Cost of capital analysis is used in taking following decisions in the organization:
Project appraisal
Financial accounting
Stock repurchases decisions
Merger & Acquisitions
Performance assessment
The estimates produced by treasury were criticized because of specific assumptions and inputs were challenged.
Options
There are two options before us just go with the cost of capital provided by treasury or revisit the assumptions and inputs and recalculate the cost of capital for specific divisions. decision While calculating D/E ratio we have added long term debt and current portion of long term debt and subtracted by cash and cash equivalent
We have calculated BV(Debt) and taken proxy for MV(Debt), for equity we have considered market value
Keeping going concern of company in mind we have taken 30-year treasury yield value in calculation
Taking cost of capital of company as hurdle rate will not be optimal because riskiness of projects from different divisions are different hence we need to calculate cost of capital separately for every division
Then based on Target D/E we have unlevered and levered the Beta value to arrive at new Beta which is aligned to Target D/E
Beta consolidated 1.37
Exploration and Production
1.55
Refining and Marketing
1.40
For calculating cost of capital for each division we have taken the Beta for each division and after levering and unlevering we have taken average to arrive at Beta for particular division and calculated cost of capital
Beta of Petrochemical business
β consolidated = sum of weighted average of assets of beta of all divisions
β petrochemicals
0.362
Sensitivity Test
Exploration and Production Refining & Marketing
D/E
WACC D/E
WACC
0%
9.18%
0%