Midland CaseTeam 1

Jacob BillsKari KrausMarcusRavisankar Gurusamy

Midland Company IntroductionMidland Energy Resources: a global energy company with operations inOil 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 lubricantsPetrochemicalsPolyethylene, polypropylene, styrene, olefins, aromatics, and fuel and lubricant additives

Current ProblemOne set of Corporate and divisional cost of capital values published by Ms. Mortensen are utilized for multiple purposes such as:Capital budgeting and Financial accountingPerformance assessmentsMerger & Acquisition proposalsStock-repurchase decisionsCost of Capital Estimates by Ms. Mortensen were often criticized and challenged (for assumptions and inputs) by division presidents and controllersMs. Mortensen identified the need for a users 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

Cost of Capital for the Company

CALCULATING THE COST OF CAPITAL FOR MIDLANDDescription of item/componentSymbolValueUnitMidlands Equity Market Value on 12/31/06 from Exhibit 5 E134,114million USDMidlands Net Debt on 12/31/06 from Exhibit 5D79,508million USDMidlands Total Market Value on 12/31/06V213,622million USDWeight for the cost of debt D/V0.3722N/AWeight for the cost of equity E/V0.6278N/AMidland's Income Before Taxes in 2006 from Exhibit 1EBIT30,447million USDMidland's Corporate income Taxes in 2006 from Exhibit 111,747million USDMidland's Corporate Tax RateT38.58%N/ACost of DebtrdN/ACost of EquityreN/ACOST OF CAPITAL FOR MIDLANDWACC0.00%

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 dataNo 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 PremiumFrom StockVal on April 10, 2007EMRP 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 RequirementsCompany 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.

**Petroleum or crude oil is a naturally occurring, toxic, flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights, and other organic compounds, that are found in geologic formations beneath the Earth's surface. Petroleum is recovered mostly through oil drilling. It is refined and separated, most easily by boiling point, into a large number of consumer products, from petrol and kerosene to asphalt and chemical reagents used to make plastics and pharmaceuticals. Natural gas is a gas consisting primarily of methane, typically with 0-20% higher hydrocarbons[1] (primarily ethane). It is found associated with other fossil fuels, in coal beds, as methane clathrates, and is created by methanogenic organisms in marshes, bogs, and landfills. It is an important fuel source, a major feedstock for fertilizers, and a potent greenhouse gas.An oil additive is used to improve the base oil (or oil "base stock") into a better performing lubricant. By utilizing the same base stock, many different oils can be manufactured, each with its own unique properties. Nearly all motor oils currently being sold have an additive package, whether they are synthetic or petroleum based. *Question 1*Question 2*Question 4*Question 5*Question 4*Question 6*Questions 3 and 7*Question 8*Question 8*Question 8*Question 8*Question 8*Question 8*StockVal calculated EMRP utilizing a proprietary market composite portfolio called The ACE Portfolio and an interactive G-model