Midland Energy Resources Inc - Case Study Example

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So, Midland should not use single corporate hurdle rate as this will cause disruption in the evaluation of the investments of the company. The evaluation should lead not mislead a company…
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Midland Energy Resources Inc
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Midland Energy Resources 3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why orwhy not?
Midland is a large company with different business unit handling different risk ration. So, Midland should not use single corporate hurdle rate as this will cause disruption in the evaluation of the investments of the company. The evaluation should lead not mislead a company .The single corporate hurdles would prompt Midlands to invest in risky projects and this would risk the whole foundation of the company. However, it would be beneficial for the company to invest in corporate level by using corporate level WACC.
4. Compute a separate cost of capital for the E & P and Marketing & Refining divisions. What causes them to differ from one another?
a) E&PrE = rf + β(EMRP)rE = 4.98% + 1.15 (5%) = 10.73%rD = rf + E&P Spread to TreasuryrD = 4.98% + 1.60% = 6.58% rE 10.73% rD 6.58% tax rate 39% D/E 39.8% E 100units D 39.8units V 139.8units E/V 0.715308 D/V 0.284692 Wacc for E&P 8.818%
b) R&MrE = rf + β(EMRP)rE = 4.98% + 1.20 (5%) = 10.98%rD = rf + R&M Spread to TreasuryrD = 4.98% + 1.80% = 6.78% rE 10.98% rD 6.78% tax rate 39% D/E 20.3% E 100units D 20.3units V 120.3units E/V 0.831255 D/V 0.168745 Wacc for E&P 9.825%.
These units differ one another because they operate at different industries. They possess different risk profiles and βs and their credit rating is also different namely; 8.818 % and 9.825 %.
5. How would you compute a cost of capital for the Petrochemical division?
The arithmetic average D/E ratio and β need to be calculated in order to find the cost of capital for Petrochemical division.
Corporate β = Average(E&P β, R&M β, Petrochemical β)1.25 = Average(1.15, 1.20,
Petrochemical β = 1.40rE = rf + β(EMRP)rE = 4.98% + 1.40 (5%) = 11.98%rD = rf +Petrochemical Spread to TreasuryrD = 4.98% + 1.35% = 6.33%
Corporate D/E = Average ( E&P D/E, R&M D/E, Petrochemical D/E)59.3% = Average(39.8%, 20.3%, Petrochemical D/E)Petrochemical D/E = 117.8% rE 11.98% rD 6.33% tax rate 39% D/E 117.8% E 100 units D 117.8 units V 217.8 units E/V 0.459137 D/V 0.540863 Wacc for Petrochemical 7.589% Read More
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