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Midland Energy Resources Case Essay

328 words - 2 pages

Question III:
Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?
It depends on what kind of investment opportunity is proposed. If it is an investment that affects the company as a whole on the corporate level then they should use a corporate rate. If it is an investment that applies only to specific divisions then that division’s hurdle rate ...view middle of the document...

The rates should be calculated and used accordingly. The divisions of Midland Energy Resources, Inc. are a bit diverse and therefore any investment opportunities should be separately evaluated based on the division that will be affected.

Question IV:
Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another?
Exploration & Production
rE = rf + β(EMRP) rD = rf + E&P treasury spread
rE = 4.98% + 1.15(5%) = 10.73% rD = 4.98% + 1.6% = 6.58%

rE = 10.73%
rD = 6.58%
tax rate = 39%
D/E = 39.8%
D = 39.8
E = 100
V = D + E = 139.8
D/V = 39.8/139.8 = 0.2847
E/V = 100/139.8 = 0.7153
WACC = rD (D/V)(1-t) + rE (E/V) = .0658(.2847)(1-.39) + .1073(.7153)
WACC = 0.08818, 8.818%

Refining & Marketing
rE = rf + β(EMRP) rD = rf + R&M treasury spread
rE = 4.98% + 1.20(5%) = 10.98% rD = 4.98% + 1.80% = 6.78%

rE = 10.98%
rD = 6.78%
tax rate = 39%
D/E = 20.3%
D = 20.3
E = 100
V = D + E = 120.3
D/V = 20.3/120.3 = 0.1687
E/V = 100/120.3 = 0.8312
WACC = rD (D/V)(1-t) + rE (E/V) = .0678(.1687)(.61) + .1098(.8312)
WACC = 0.09825%, 9.825%

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