Midland Questions 
Professor Smith
Midland Energy Resources, Inc.: Cost of Capital Case Questions
This case provides an opportunity to determine what cost of capital firms should use when firms are evaluating investment opportunities. The case addresses what inputs should be used in estimating the opportunity cost of capital for investors as well as which firms should be identified as comparables.
1. How are Mortensen’s estimates of Midland’s cost of capital used? How, if at all, should these anticipated uses affect the calculations?
2. Calculate Midland’s corporate WACC. Be prepared to defend your specific assumptions about the various inputs to the calculations. Is Midland’s choice of equity market risk premium appropriate? If not, what recommendations would you make and why?
3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?
Shouln’t. With different divisions, each containing its own unique set of risks
4. Compute a separate cost of capital for the Exploration and Production (E&P) and the Marketing and Refining (M&R) divisions. What causes them to differ from one another?;44=
5. How would you compute a cost of capital for the Petrochemical division?
2. From Table 1
For consolidated :
D/V= 42.2%
E/V = 1 – D/V =57.8%
Assume the tax rate is the average rate generated from year 2004, 2005 and 2006 (from Exhibit 1)
2004 7,414/17,910 = 41.40%
2005 12,830/32,723 = 39.21%
2006 11,747/30,447 = 38.58% t =(41.40%+39.21%+38.58%)/3=39.73% + spread to treasury = 4.98%+1.62%=6.6% = 4.98%+1.25×5% = 11.23%
WACC =6.6%×42.2%×(1-39.73%) +11.23%×57.8% = 8.17%
4. E&P
D/V = 46.0%
E/V = 54.0%
0.93
] = 0.93*[1+ (1-39.73%)* = 1.41 = 4.98%+1.41×5% = 12.03% + spread to treasury = 4.98%+1.60% = 6.58%
WACC =6.58%×46%×(1-39.73%) +12.03%×54% = 8.32%
R&M
D/V = 31%
E/V = 69%
1.05
] = 1.07*[1+ (1-39.73%)* = 1.33
= 4.98%+1.33×5% = 11.63% + spread to treasury =
Midland Energy Resources, Inc.: Cost of Capital Case Questions
This case provides an opportunity to determine what cost of capital firms should use when firms are evaluating investment opportunities. The case addresses what inputs should be used in estimating the opportunity cost of capital for investors as well as which firms should be identified as comparables.
1. How are Mortensen’s estimates of Midland’s cost of capital used? How, if at all, should these anticipated uses affect the calculations?
2. Calculate Midland’s corporate WACC. Be prepared to defend your specific assumptions about the various inputs to the calculations. Is Midland’s choice of equity market risk premium appropriate? If not, what recommendations would you make and why?
3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?
Shouln’t. With different divisions, each containing its own unique set of risks
4. Compute a separate cost of capital for the Exploration and Production (E&P) and the Marketing and Refining (M&R) divisions. What causes them to differ from one another?;44=
5. How would you compute a cost of capital for the Petrochemical division?
2. From Table 1
For consolidated :
D/V= 42.2%
E/V = 1 – D/V =57.8%
Assume the tax rate is the average rate generated from year 2004, 2005 and 2006 (from Exhibit 1)
2004 7,414/17,910 = 41.40%
2005 12,830/32,723 = 39.21%
2006 11,747/30,447 = 38.58% t =(41.40%+39.21%+38.58%)/3=39.73% + spread to treasury = 4.98%+1.62%=6.6% = 4.98%+1.25×5% = 11.23%
WACC =6.6%×42.2%×(1-39.73%) +11.23%×57.8% = 8.17%
4. E&P
D/V = 46.0%
E/V = 54.0%
0.93
] = 0.93*[1+ (1-39.73%)* = 1.41 = 4.98%+1.41×5% = 12.03% + spread to treasury = 4.98%+1.60% = 6.58%
WACC =6.58%×46%×(1-39.73%) +12.03%×54% = 8.32%
R&M
D/V = 31%
E/V = 69%
1.05
] = 1.07*[1+ (1-39.73%)* = 1.33
= 4.98%+1.33×5% = 11.63% + spread to treasury =