Midland Energy Resources, Inc. Case Study
We choose arrear US tibia rate because most of the large firms, such as Midlands, usually use the longer yield of the U.
S Treasury bond to determine risked rate. Similarly, to estimate the cost of equity, we use the CAMP: re=RFC+ beta*(EMMER). Beta for Mainland is 1.25 base on commercially available database. After reviewing the recent research, Midland adopts an EMMER of 5%.
The cost of debt is 6.6% while the cost of equity is 11.23% for Midland. Therefore, the WAC is 8.16% based on the estimate of 42.
0% leverage and tax rate of 40%. Actual Leverage Deferent From Target If the actual leverage ratio is lower than 42.2%,WAC for Midland will increase. On the other hand, if the actual leverage ratio is higher than 42.2%, WAC will decrease. The key reasoning is that the cost of debt is less than the cost of equity.
Consequently, the change in re*(EN) is greater than the change in
Single Corporate WAC for Evaluation Purpose We should not use a single corporate WAC for evaluating investment opportunities In all its division. The firm should value its projects using a discount rate determined y the characteristics of the risk of the project rather than a single accompanied discount rate. Deferent divisions have different weighted average cost of capital. If we use the single discount rate of the company, then we will overdrives or underwrites in division whose beta Is higher or lower than the firm’s core beta.
WAC for E division and marketing ; refining dolls First, the risk free rate and the market premium Is 4. 98% and 5% respectively.
Second, by the rating of the two dollops and the table In 12.0, we got the cost of debt Is 5.3% and 5.48% respectively. And similarly, we calculated the cost of equity, which is 10.
73% and 10.98%. Then the WAC for E division is 7.24% and the WAC Tort marketing ; renting Loves Is B WAC Is Deterrent Tort tense two Loveless because of the difference in risk profiles and the operations in different industries. For example, betas and credit ratings are different depending on the divisions.
Refining ; Marketing division has a lower credit rating( EBB) than Exploration ; Production division, as a result, its spread to treasury is higher. The higher spread leads to a higher cost of debt for Marketing ; Refining division. In addition, the capital structure is different for different divisions. The D/Of Marketing ; Refining is 31% while that of Exploration ; Production is 46%.
WAC for petrochemical industry using Comparable Method We chose four companies which are all in the petrochemical industry and have the similar capital structure as the Midland Energy Resource Inch’s petrochemical division. These four companies are Since Shanghai Petrochemical Co. , Barrio Pacific Tab, Ultra Holdings, and TAP Group Inc.
Then we got the average DON and average Equity Beta based on the data from Capital IQ and Bloomberg. The debt beta of Midland’s petrochemical division is 0. 05 as its credit rating is AAA. As a result, the WAC of the petrochemical division is 7. 17%.
WAC for petrochemical division based on data in the case Based only on the data given in the case, we got the WAC of the petrochemical division equal to 8. 41%. First, from question 4, we can calculate the asset beta for E, marketing ; refining and whole company using formula: asset beta=Bad*(DON)+Be*(1 DAD, where Bad represents debt beta and Be represents equity beta. Then based on the percentage east of each division we got the asset beta for petrochemical division. Since the beta of the debt of petrochemical division is 5%, we got the equity beta that is 1.39.
Using the above data, we got the rd and re of petrochemical division and then the WAC.
