Midland Energy Resources

Case Study 7

Midland Energy Resources is a global energy company that operates in oil and gas exploration and production (E & P) to provide a wide range of products and services to oil and gas customers around the world, including refining and sales (R & M), natural gas and Petrochemical products. Janet Mortensen, Senior Vice President, Financing for Energy Resources at Midland Energy, must determine the weighted average cost of capital (WACC) for the entire company, and each sector as part of the annual capital budget process.

Mortensen's cost capital is used for capital budgeting, financial accounting, performance evaluation, stock repurchase estimates. Capital costs are also a necessary basis for expected growth and projected demand. Since the use of Mortensen's cost capital in different divisions is not a publicly traded individual, it is not possible to obtain the relevant beta value by looking for other companies that have a business similar to the midland sector, and then by calculating these beta values Average of the way to estimate the beta of the relevant departments.

According to the calculation, Midland Company WACC was 8.48%. First, I chose 2007 US Treasury bonds (4.98%) as the risk-free rate used in the 2007 WACC calculations. The reason is that most large companies and financial analysts use long-term bond yields to determine risk-free rates. Then, it begins to calculate the cost of the debt, which is determined by adding the A + Treasury coupon to the 2007 30-year Treasury bond. That is 4.98% + 1.62% = 6.60%, which is the cost of the debt. Third, the benefits of the next cost. EMRP (5%) is removed from the background of the case. The tax rate (39.73%) is the average of the taxes paid between 2004 and 2006. Next, we need to calculate the leveraged β, βu = (E / E + D) * βe + (D / E + D) * βd by the formula. βd = 0 because we cannot find the debt beta through this situation. In this formula, the unlocked beta (0.7847) was obtained using the recently discovered D / V ratio (59.30%) and multiplied by the interest β (1.25). In order to make βe a value, we use the formula βe = βu + (D / E) * (βu - βd). And "target D / E" is found by dividing "target D / V" by "1 target D / V". So get the new beta, 1.3576. Then we get the equity cost, we use the CAPM formula, Re = Rf + β (EMRP), 11.7679%. Since equity costs and debt costs have been obtained, it can be determined that WACC equals equity / value * equity costs + debt / value * debt costs * (1 tax rate). And finally reached 8.48%. In this case, Midland's choice of a 5% market risk premium seems to be an appropriate choice. According to the exhibition 6, we found that this EMRP is lower than the US stock returns minus the national debt yield data, higher than the market risk premium of the survey results. So we recommend reducing the risk premium rate to 4.8% to 5.6%. The higher EMRP was 4.8% and the lower EMRP was 5.6%. All in all, 5% is a reasonable market risk premium.

Midland should not rely on a single business hurdle to assess investment opportunities in all sectors, because the barrier rate is a key factor in determining whether we should accept the project, it concerns the specific investment opportunities that belong to a sector, and the Midland divisions have Own target debt ratio. These objectives are based on the consideration of the annual operating cash flows of each sector and the value of their identifiable assets. On the other hand, the risk of investment opportunities is different. For example, in 2007 and 2008, R & E expects capital spending to exceed $ 8 billion, while global refining capacity is expected to decline, potentially investing in Midland's sector. Exploration and production departments face a completely different challenge, because as the Arctic and Deepwater drilling operations, oil reserves become more difficult to achieve, so the higher cost of mining. In addition, due to the Middle East and Africa and other regions of the oil production growth, political instability in investment considerations increasingly common. Citizens and political turmoil in these areas threaten the disruption of oil production and lead to greater price volatility. As a result, higher risk projects should have a higher barrier rate, while lower risk projects should reduce their barriers.