Midland Energy Resources

Answer Case Study 2
Midland Energy Resources (as a whole company)
According to the article, the beta of Midland Energy 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 beta. The formula is
Asset beta = equity beta/[1 + (D/E) * (1-t)];
D/E=

Midland Energy Resources
E&P
R&M
Equity beta
1.25
1.15
1.20
D/E
59.3%
39.8%
20.3%
Tax rate
39.73%
39.73%
39.73%
Asset beta
0.9208
0.9275
1.0692
New D/V
42.2%
46.0%
31.0%
New D/E

85.19%
44.93%
New equity beta

1.4037
1.3587

According to Exhibit 3, the weights of assets of each division is
Weight of E&P = 140100/ (140100 + 93829+28450) = 53.40%
Weight of R&M = 93829 / 262379 = 35.76%
Weight of Petrochemicals = 1 – 53.40% - 35.76% = 10.84%
0.9208 = 53.40% * 92.75% + 35.76% * 1.0692 +