Financial Management Midland Energy Resources Finance Essay

Financial Management Midland Energy Resources Finance EssayIn the Midland Energy Resources outcome study we see that it has its operations divided amongst three separate divisions. All these three divisions look at different functions and need a separate discount rate to evaluate its projects. Midland personas its cost of capital for many different ways. In order to discount Midlands cash flows we use the plodding average cost of capital. Here the cost of debt is easier to picture by taking the bond yield plus risk premium approach. The Capital Asset set Model is used to calculate the cost of equity. In case of CAPM, the calculation of beta requires significant judgment. We use the industry data to calculate the beta.Solution 1Mortensens estimates are used for the followingIn case of asset appraisals for capital budgeting and financial accountingIn case of MA proposalsIn case of perspicacity of performancesIn case of stock repurchase decisions at different divisions and trans action unit levels.Solution 2Calculating rDIn this case Mortensen computed the cost of debt for to each one of the three divisions by adding a premium over the US treasury securities of a similar maturity.In order to find rD, we do not use CAPM but we use the interest rate that we are currently paying on the new loans.Here we see that the consolidated spread to treasury is granted as 1.62%Thus, rD = 30 year yields to U.S exchequer bonds + Overall Consolidated Spread to TreasuryrD = 4.98% + 1.62%rD = 6.60%Calculating the Tax rateThe tax rate is calculated on the basis on the Exhibit 1 as average over the years 2004, 2005 and 2006.Therefore the tax rate come out to be (Midlands Income Taxes / Midlands Income in front Taxes and the fair(a) across 2004, 2005, 2006)= 39%Calculating EMRPBased on the exhibit in this case, we see that the traditional data showed is approximately 6.0% EMRP and the surveys show lower EMRP (2.5% to 4.7%) establish on a re appear over the industry with the help from outsiders who have broader industry knowledge, which would result in a better and up-to-date EMRP.Researches in credit with its professional advisors, bankers and investors, as well as Wall Street analysts covering the industry agreed on the current estimate of 5.0%.As the analysts on the industry, bankers and investors have broader information from different companies and executives, it can be concluded that the approach of outside consulting and the result of 5.0% estimate is appropriate.Calculating rEHere we use 5.0% as its truth Market Risk Premium.The collective is publicly available, and as it represents merged level , well use 1.25 as it is for Overall Corporate WACC calculation.rE = rf + (EMRP)rE = 4.98% + 1.25 (5%) = 11.23%Calculating WACCGiven + Calculated information rE 11.23%, rD 6.60%, tax rate 39%, D/E 59.3%, E= degree Celsiusunits, D =59.3units, V=159.3units,E/V= 0.62774639, D/V=0.37225361Using the formula we get, WACC =rE(E/V) + rD(D/V) (1-t)= 8.548%S olution 3The company here, Midland, is a large enterprise and has diverse business units with different risks. In the case here we see that the Equity Beta represents the risk factor of those divisions. (Exhibit 5).We also see here that the risk profiles and different here as per the division and the hurdle rates for those divisions should also be different and calculated based on the of the divisionIn this case Midland should not use single corporate hurdle rate as this will mislead evaluation of the investments, and will result on Midland invest on risky projects and will plow risky a corporate by timeBut on the other hand if Midland invests on corporate level using the corporate level WACC.Solution 4Calculating EPrE = rf + (EMRP)rE = 4.98% + 1.15 (5%) = 10.73%rD = rf + EP Spread to TreasuryrD = 4.98% + 1.60% = 6.58%rE =10.73%rD =6.58%tax rate= 39%D/E= 39.8%E=100unitsD=39.8unitsV=139.8unitsE/V =0.715308D/V= 0.284692WACC for EP= 8.818%Calculating RMrE = rf + (EMRP)rE = 4.98% + 1 .20 (5%) = 10.98%rD = rf + RM Spread to TreasuryrD = 4.98% + 1.80% = 6.78%rE= 10.98%rD= 6.78%Tax rate= 39%D/E= 20.3%E= 100unitsD= 20.3unitsV= 120.3unitsE/V =0.831255D/V= 0.168745The value of WACC = 9.825%The business units all these industries of Midland operate on are different and thus they have different risk profiles and s and also different credit ratings. as well as as a result the EP and RM have different WACC values.Solution 5In order to calculate the cost of capital in case of Petrochemical, we would search for the couple of companies which focus only on Petrochemical industry and then use their fact sheet in order to get an average on their and D/E ratio.By taking into account the data available to us (exhibit 5) and using the arithmetic averages on D/E ratio and we can calculate cost of capital for Petrochemical division.Corporate = Average (EP , RM , Petrochemical )1.25 = Average (1.15, 1.20, Petrochemical )Petrochemical = 1.40rE = rf + (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 ( EP D/E, RM 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 unitsD= 117.8 unitsV= 217.8 unitsE/V= 0.459137D/V= 0.540863The value of WACC = 7.589%