Midland Case

Team 1

Jacob BillsKari Kraus

MarcusRavisankar Gurusamy

Midland Company Introduction

• Midland Energy Resources: a global energy company with operations in– Oil and Gas Exploration (E&P)

• searching for potential underground or underwater oil and gas fields, drilling of exploratory wells, and subsequently operating the wells that recover and bring the crude oil and/or raw natural gas to the surface.

– Refining & Marketing (R&M)• Gasoline and base-stock lubricants

– Petrochemicals• Polyethylene, polypropylene, styrene, olefins, aromatics, and

fuel and lubricant additives

Current Problem

• One set of Corporate and divisional cost of capital values published by Ms. Mortensen are utilized for multiple purposes such as:– Capital budgeting and Financial accounting– Performance assessments– Merger & Acquisition proposals– Stock-repurchase decisions

• Cost of Capital Estimates by Ms. Mortensen were often criticized and challenged (for assumptions and inputs) by division presidents and controllers

• Ms. Mortensen identified the need for a ‘user’s guide’ to interpret and use the cost of capital estimates appropriately to address the above issues

Risk-Free Rate

Equity Market Risk Premium

Equity Beta for the Company

Cost of Equity for the Company

Debt Beta for the Company

Cost of Debt for the Company

CALCULATING THE COST OF CAPITAL FOR MIDLAND

Description of item/component Symbol Value Unit

Midland’s Equity Market Value on 12/31/06 from Exhibit 5 E 134,114 million USD

Midland’s Net Debt on 12/31/06 from Exhibit 5 D 79,508 million USD

Midland’s Total Market Value on 12/31/06 V 213,622 million USD

Weight for the cost of debt D/V 0.3722 N/A

Weight for the cost of equity E/V 0.6278 N/A

Midland's Income Before Taxes in 2006 from Exhibit 1 EBIT 30,447 million USD

Midland's Corporate income Taxes in 2006 from Exhibit 1   11,747 million USD

Midland's Corporate Tax Rate T 38.58% N/A

Cost of Debt rd   N/A

Cost of Equity re   N/A

COST OF CAPITAL FOR MIDLAND WACC 0.00%  

Cost of Capital for the Company

Weights for the cost of capital for the Exploration & Production

Division

Equity Beta for the Exploration & Production Division

Cost of Equity for the Exploration & Production Division

Debt Beta for the Exploration & Production Division

Cost of Debt for the Exploration & Production Division

Cost of Capital for the Exploration & Production Division

Issues with case data

• No strong rationale presented for why some overseas projects were analyzed based on cost of equity (vs WACC)

• If the corporate investments in these overseas projects were specifically made from equity only, then this makes sense

Backup Slides

Equity Market Risk Premium• From StockVal on April 10, 2007

• EMRP in Y-axis; 2006 range >4% to ~5%, supports the 5% used by Midland in 2006

• Years 1972 – 2007 in X-axis

http://www.drkash.com/site/index.php?option=com_docman&task=doc_view&gid=274

Presentation Requirements

• Company Presentation Instructions: You will prepare a PowerPoint presentation. Each member must play some role in relaying the data of the case as this is part of your overall assignments grade. You will start with a brief introduction of the company and the current problem Ms. Mortensen is facing. Please use spreadsheet solutions to show how you arrived at calculations. You should address each of the questions in the case, numbered 1-7. You are tasked to cover only the company cost of capital and not any divisional costs. You should also answer the 2nd of the in-class discussion questions.