Midland Energy Resources has its operations partitioned amongst three separate divisions. The divisions have distinctive capacities and need separate markdown rate to assess its ventures. The expense of capital is extremely basic in Midland as it utilized for some various purposes. In this manner, it is vital to compute an exact expense of capital. The Weighted Average Cost of Capital is utilized to rebate Midland's money streams. Expense of obligation is relatively simpler to figure utilizing a 'bond yield in addition to hazard premium' methodology. The expense of value is computed utilizing the Capital Asset Pricing Model (CAPM). In CAPM, the estimation of beta requires huge judgment. Industry information is utilized to compute the beta, however such information is not accessible for one of the divisions where an option technique is connected. There is likewise some discussion in utilizing the business sector hazard premium: the recorded danger premium for US stocks altogether varies from the danger premium utilized as a part of the business. By making certain suspicions about these variables, four separate expenses of capital are assessed for Midland and its three divisions.
1. What should be the cost of capital for Midland operational divisions?
2. How are Mortensen’s estimates of Midland’s cost of capital used? How, if at all, should these anticipated uses affect the calculations?
3. Is Midland’s choice of an expected market risk premium for equity appropriate? If not, do you have alternatives you might suggest?
4. Calculate Midland’s corporate WACC. Be prepared to defend your specific assumptions about the various inputs to the calculations. Is Midland’s choice of EMRP appropriate? If not, what recommendations would you make and why?
5. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?
6. Calculate a separate cost of capital for the E&P and Marketing & Refining divisions.What causes them to differ from one another? Should all of the firm’s shown in Exhibit 5 we used in estimating betas for these two divisions or should some be excluded? If you decide to exclude some, what would be the basis for their exclusion?
7. The case does not provide comparable company information for petrochemicals division. How should Janet Mortensen develop a divisional WACC might be developed for petrochemicals?
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