...Midland Energy Resources, Inc.: Cost of Capital This case describe an global energy company, whose name is Midland, with three operations in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. We are going to calculate the cost of the capital of this company, and answer the following three questions. What are the cost of capital for Midland debt and equity? What is the WACC for Midland? What should be the cost of capital for Midland operational divisions? Cost of Debt Assume the business is on-going for a long period of time. We use 4.98% rate as Rf from 30 years U.S. Treasury bond. Rd=Rf+Spread to Treasury Consolidated: Rd=4.98%+1.62%=5.6% Exploration & Production: Rd=4.98%+1.60%=6.58% Refining & Marketing: Rd=4.98%+1.80%=6.78% Petrochemicals: Rd=4.98%+1.35%=6.33% Cost of Equity To calculate the cost of equity, we use the Capital Asset Pricing Model. Rf stands for the risk-free rate of return, B is a measure of systematic risk, and EMRP denotes the equity market risk premium. For EMRP, Midland adopted the estimate of 5.0%. We assume the Beta for Exploration & Production and Refining & Marketing is the average of the companies listed in Exhibit 5, which are 1.15 and 1.20, respectively. We also assume the company’s Beta is the weighted average of the three operations an assets level, which is 1.25. Then the Beta for Petrochemicals is calculated to be 1.91. Consolidated:...
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...Chengze Chen Kevin M. Sweeney 04/17/2015 Midland Energy Resources Case Analysis Midland is an international energy company whose businesses include oil and gas exploration, refining and marketing and petrochemicals. In 2006, its revenue has reached $248.5 billion while its income is $42.2 billion. Midland’s capital planning model basically depends on the macro financial market and strategy of the overall company in 2007, which includes stimulating the overseas growth, investing in valuable projects, optimizing its capital structure and to repurchase undervalued shares. It firstly allows Midland to figure out the reasonable amount of financing, range of capital structure, and WACC for the whole company basing on the required interest rate of market. Then, Midland could use its capital planning model to make adjustments on WACC of the whole company so that it will become more suitable for each division, which can apparently reduce the possibility of making mistake when division managers chose projects. Finally, the capital planning model provides reliable methods for Midland to allocate the capital to three divisions according to each strategies and operation performance. In this case, Janet Mortensen, as a senior vice president of project finance for Midland Energy Resources, should play a vital role in using the capital planning model appropriately to make project decision. She should firstly stand on the perspective of the whole company, than take the differences among...
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...Midland Energy Resources, Inc.: Cost of Capital May 28, 2014 1. For what purposes dose Mortensen estimated Midland’s cost of capital? What would be the potential consequences of a too high estimate compared to the firm’s “true” cost of capital? What about a too low estimate? Estimates of Midland’s cost of capital are used in many analyses, including asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. They were performed at division of business unit level as well as corporate level. In addition, the estimated cost of capital is an essential component in WACC and discounted cash flow calculations that can help Midland evaluate the expected growth and prospective investments. A too high estimate of Midland’s cost of capital causes a lower NPV because of the higher discount rate. As a result, Midland decision makers will undervalue and may give up the promising investment that they were holding. Besides that, the shareholders will probably see a lower return on their investment. Midland will miss some profitable investment opportunities. On the other hand, if the estimate of the cost of capital were too low, NPV would be larger than they should be. Midland decision maker may take some risker projects by holding unprofitable investment based on this overestimated NPV. The market price of the company may be overvalued. The shareholders will see an over inflated...
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...Midland's cost of capital 1. I choose the rate of 30-year U.S. Treasury bonds in 2007 (4.98%) as the risk free rate in the 2007 WACC calculations. The reason is that majority of large firms and financial analysts report using long-term yields for bonds to determine the risk-free rate. Rf=0.0498 2. Cost of debt, which is determined by adding the spread to Treasury (1.62%) to the rate of 30-year treasury bonds in 2007. Rd=0.0498+0.0162=0.066 3. Cost of equity, the EMRP (5%) and D/E (59.3%) was taken out of the context of the case. βa=Equity Beta/(1+D/E)= 1.25/(1+0.593)= 0.78 According to Table1, consolidated D/V is 42.2%, E/V is 57.8%, βe= βa*(1+D/E)= 0.78*(1+0.422/0.578)=1.35 Re=Rf+ βe *EMRP= 0.0498+(1.35*0.05)= 0.1173 4. WACC, the tax rate (38.58%) was from the 2006 taxes paid. WACC= D/V*(1-T)*Rd+E/V*Re= 0.422*(1-0.3858)*0.066+0.578*0.1173=8.49% The division costs of capital Exploration & Production 1. I also use of 30-year U.S. Treasury bonds in 2007 (4.98%) as the risk free rate, Rf=0.0498. 2. Cost of debt, Rd=Rf+ the spread to Treasury(Exploration & Production)=0.0498+0.016=0.0658 3. Cost of equity, EMRP=5%. Since we can’t get the beta of E&P, we should use the information of comparable companies on Exhibit 5 to get average asset beta, and then to calculate the beta of E&P. βa=Equity Beta/(1+D/E)= 1.15/(1+0.398)= 0.82 According to Table1, consolidated D/V is 46%, E/V is 54%, βe= βa*(1+D/E)= 0.82*(1+0.46/0.54)=1.52 Re=Rf+...
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...appropriate target for AGI. AGI is looking to increase its revenue and profit by utilizing synergies. The initial aim of AGI for acquiring Mercury Athletics is to increase leverage with contract manufacturers and to boost the cooperation with the retailers and distributors. AGI was one of the most profitable and successful companies in the market segment, but the firm’s size remained rather small in comparison with the main competitors. Therefore, with the acquisition of Mercury, AGI planned to build competitive advantage. Besides, the target company had well developed operation infrastructure, impressive labor facilities in China and numerous possibilities in reaching the markets in Asia. 2. Review Liedtke’s projections stated in the case. Are they reasonable? How would you recommend modifying them? [Hint: Calculate ratios and margins for the projections and compare these to the historical relationships.] Mercury’s EBIT margin for 2006 was 9.8%. Liendke’s 2007 projected EBIT reflects a conservative increase in EBIT of 9% compared to the average industry growth rate of 10%. According to the forecast for 2007 to 2011, the company is forecasted to show gradual and stable growth of consolidated income from $479.3 million to $597.7 million. This growth rate was estimated by assuming that men’s athletic department sales will be declining from 15% in 2007 to 5% in 2011. Similar trends are assumed for women’s athletic department which the growth rate is forecasted to decrease...
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...Midland Energy/Sample 2 Midland Energy Resources, Inc. Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Midland’s most profitable segment is its E&P division which produces 67% of the company’s net income (Exhibit 3). Its largest division is R&M with the Petrochemical division being the smallest. The primary goals of Midland’s financial strategy are to fund substantial overseas growth, invest in value-creating projects, achieve an optimal capital structure, and repurchase undervalued shares. To accomplish these goals, Midland must calculate an appropriate cost of capital that will allow reasonable valuations of their strategies. In funding overseas growth, Midland must use its cost of capital to analyze, evaluate, and convert foreign cash flows. In evaluating value-adding projects, the cost of capital must be used to discount project cash flows. To optimize its capital structure, the company must continuously evaluate its ideal borrowing based on its inherent cost. Lastly, when deciding when and how to repurchase shares, Midland’s management has to determine the intrinsic value of its shares. This requires determining the value of the company using DCF techniques and an appropriate discount rate. Cost of Capital Estimates of Midland’s cost of capital are used in analyses within the company and its three divisions. These analyses include...
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...hace Midland del EMRP (Equity Market Risk Premium)? ¿Por qué? Si no la considera apropiada, ¿Qué recomendaciones haría?, y ¿por qué? En este caso de estudio, el rendimiento de los bonos del Estado han sido tomados como una medida de rendimiento libre de riesgo. Sin embargo, el rendimiento libre de riesgo puede ser tomado para ser otro tipo de rendimiento también. En el Exhibit 6 del caso, la cantidad de Premium difiere, dependiendo del tiempo seleccionado. El menor valor para el EMRP es de 4.8% para el periodo entre 1967 y 2006. El EMRP incrementa drásticamente si un horizonte del tiempo mayor o menor es utilizado. Por lo tanto, utilizando información histórica, 4.8% puede ser visto como la estimación más conservativa del EMRP. Bajo este estándar, el EMPR de Midland de 5% es muy conservador. Sin embargo, los resultados sobre el EMRP en el Exhibit 6 pintan como una historia diferente. Las encuestas de académicos, directores de fondos de pensiones y otras empresas americanas sugieren que utilizan un estimado mucho menor para el EMRP entre 3% y 4%. Se cree que el EMRP utilizado por Midland del 5% es apropiado. La información histórica sugiere que el 5% es conservador, mientras que las encuestas sugieren que otros interesados utilicen un EMRP aún más bajo. La única alternativa creíble sería utilizar un EMRP más bajo para poder cumplir mejor con los estándares de la industria. Sin embargo, no sería una buena alternativa pues pudiera minimizar el costo del capital para Midland. Un...
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...Midland Energy Resource Case Analysis 1. Describe Midland, its capital planning model and Janet Mortensen's role in the case. Midland Energy Resource, Inc. has three major divisions: Exploration & Production (E&P), Refining and Market (R&M), and Petrochemicals. E&P division provides the most profit for Midland. R&M is the largest division in Midland by revenue. Petrochemicals is the smallest division in Midland. Midland’s financial strategy in 2007 consisted of four principals: funding significant overseas growth, investing in value-creating projects, optimizing corporate capital structure, and repurchasing undervalue shares. Janet Mortensen, senior analyst reporting to CFO, takes role of estimating Midland’s cost of capital for various analyses, both corporate and division level, throughout the company. Her main method is using Weighted Average Cost of Capital (WACC) formula to evaluate required Cost of Capital estimate. 2. Briefly explain the meaning of the following concepts: cost of capital, WACC, and CAPM. Cost of Capital: the minimum acceptable rate of return for new investments in the corporation. The opportunity cost of investing. WACC: Weighted Average Cost of Capital, a calculation of company’s cost of capital, which is seemed as composite cost of debt and equity. Every category of capital in WACC is proportionally weighted. CAPM: Capital Asset Pricing Model, a theory representing the financial market behavior. Used to estimate...
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...Midland Energy Resources Case Analysis Midland Energy Capital Planning Model • Fund significant overseas growth • As domestic natural resources dwindle, overseas investments are the main drivers of growth for Midland. These investments are analyzed and evaluated is US dollars (foreign cash flows are converted to US dollars) and have a US dollar discount rate applied to them. In 2006, 77.7% of Midland’s total earnings from equity affiliates came from non-US investments. • Invest in value creating projects across all divisions • Midland generally used traditional discounted cash flow methods to evaluate potential projects and investments. Some overseas projects were analyzed as streams of future equity cash flows, and were discounted based on cost of equity as a result. Once funded, a project/investment’s performance was measure in two ways. The first being actual performance vs forecasted plan over 1, 3, and 5 year periods, and the second being Economic Value Added (EVA). EVA was calculated as: EVA = EBIT(1-t) – WACC(period capital expenditure) Midland Energy Capital Planning Model • Optimize capital structure • Midland primarily optimized its capital structure by taking advantage of the borrowing capacity inherent in its energy reserves and long term assets, such as refining facilities. Midland maintained an optimal debt level which was based on energy prices and its own stock prices. This practice allowed them to shield additional profits from...
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...of this structure against other types of organizational structure. The FTSE UK index series is designed to represent the performance of UK companies, providing investors with a comprehensive set of indices that measure the performance of all capital and industry segments of the UK equity market. HSBC is on the 3rd rank of FTSE 100. History of HSBC HSBC Bank plc and its subsidiaries form a UK-based group providing a comprehensive range of banking and related financial services. HSBC Bank plc (formerly Midland Bank plc) was formed in England in 1836 and subsequently registered as a limited company in 1880. In 1923, the company adopted the name of Midland Bank Limited which it held until 1982 when the name was changed to Midland Bank plc. During the year ended 31 December 1992, Midland Bank plc became a wholly owned subsidiary undertaking of HSBC Holdings PLC (“HSBC Holdings”), whose Headquartered is in London. HSBC Bank plc adopted its current name, changing from Midland Bank plc, in the year ended 31 December 1999. The HSBC Group is one of the largest banking and financial services organisations in the world, with over 9,500 offices in 79 countries and territories in Europe, Hong Kong, the rest of Asia-Pacific, including the Middle East and Africa, North America and South America. Its total assets at 31 December 2009 were £579 billion. The Bank is the HSBC Group’s principal operating subsidiary undertaking in Europe. As at 31 December 2003, the Bank’s principal subsidiary...
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...Midland Energy Resources, Inc. Midland Energy Resources, Inc. Is a global energy company with three major divisions, including oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Midland has been a profitable company over the past few years. In 2006, the firm, on a consolidated basis, had operating revenue and operating income of $248.5 billion and $42.2 billion respectively. Among these three divisions, E&P was Midland’s most profitable business, R&M was Midland’s largest business, and Petrochemical was Midland’s smallest yet still substantial business. In 2007, Midland’s financial strategy will mainly focuses on four aspects: 1) Fund Overseas Growth; 2) Value-creating Investments; 3) Optimize Capital Structure; 4) Repurchase undervalued stocks. Fund Overseas Growth: Due to the exploited domestic resources in the domestic market, overseas investment will be the main sources for economic growth in Midland as a form of specialized financial and contractual arrangements similar to project financing, all of which are valued in dollars. Value-creating Investments: Discounted Cash Flow (DCF) methods, involving debt-free cash flows and a hurdle rate equal to or derived from the WACC for the project of division, are typically used to evaluate most prospective investment, yet for overseas projects are evaluated as streams of future equity cash flows and discounted as a rate based on the cost of equity. Optimize Capital Structure: Midland optimized...
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...Midland Energy/Sample 2 Midland Energy Resources, Inc. Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Midland’s most profitable segment is its E&P division which produces 67% of the company’s net income (Exhibit 3). Its largest division is R&M with the Petrochemical division being the smallest. The primary goals of Midland’s financial strategy are to fund substantial overseas growth, invest in value-creating projects, achieve an optimal capital structure, and repurchase undervalued shares. To accomplish these goals, Midland must calculate an appropriate cost of capital that will allow reasonable valuations of their strategies. In funding overseas growth, Midland must use its cost of capital to analyze, evaluate, and convert foreign cash flows. In evaluating value-adding projects, the cost of capital must be used to discount project cash flows. To optimize its capital structure, the company must continuously evaluate its ideal borrowing based on its inherent cost. Lastly, when deciding when and how to repurchase shares, Midland’s management has to determine the intrinsic value of its shares. This requires determining the value of the company using DCF techniques and an appropriate discount rate. Cost of Capital Estimates of Midland’s cost of capital are used in analyses within the company and its three divisions. These analyses include asset appraisals...
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...Cost of Capital Estimate for Midland Energy Resources, Inc. In the first section of my report, I list out the main models and methods applied to estimate the cost of capital for Midland’s three divisions, general assumptions made and the corresponding justifications. In the second section, Calculations, I not only compute the cost of capital based on the general assumptions previously made, but also discuss specifics of each division and the additional adjustments or assumptions made to justify my estimates. SECTION 1: Main models and methods applied and corresponding assumptions 1. Constant Debt-ratio Weighted Average Cost of Capital (WACC): WACC=rdDV1-t+reEV Assumptions: * WACC: as constant debt ratio is the underlying assumption to derive the WACC model, constant debt ratio should be reasonably assumed to be applied by Midland and its three divisions. According to the case, Midland optimizes its debt levels by regularly reevaluations against its energy price and stock price level and each division has its own target debt ratio. Although the actual capital structure sometimes deviates from the target due to factors such as market value of specific collaterals, it is safe to assume that the debt ratio averages out at the target ratio in the long run, given that the target ratios are not adjusted frequently. Therefore, the debt ratio can be viewed as a constant and thus WACC is applicable. * Capital structure: as assumed above, target debt ratio is employed in...
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...Chapter 1: Introduction to HSBC Group 1.0 HSBC Mission Statement: “We aim to satisfy our customers with high quality service that reflects our global image as the premier international bank” Objectives of HSBC: HSBC’s objectives are to provide innovative products supported by quality delivery of systems and excellence customer services, to train and motivate staffs and to exercise social responsibility. By combining regional strengths with group network HSBC’s aim is to be the one of the leading banks in its principle markets. HSBC’s goal is to achieve sustained earnings growth and to continue to enhance shareholders value. 1.1 An Overview of HSBC Group The HSBC Group is named after its founding member, The Hongkong and Shanghai Banking Corporation Limited, which was established in 1865 in Hong Kong and Shanghai to finance the growing trade between China and Europe. Thomas Sutherland, a Hong Kong Superintendent of the Peninsular and Oriental Steam Navigation Company helped to establish this bank in March 1865. Throughout the late nineteenth and the early twentieth centuries, the bank established a network of agencies and branches based mainly in China and South East Asia but also with representation in the Indian sub-continent, Japan, Europe and North America. The post-war political and economic changes in the world forced the bank to analyze its strategy for continued growth in the 1950s. The bank diversified both its business and its...
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...In this case, the parties asked the court to focus on the legitimacy of a local government’s exercise of its power of eminent domain. Eminent domain is a power of the government to take land for public use. Under an agreement with the town of Monroe, North Carolina, the town of Midland began to acquire the rights of way to local land for the installation of a natural gas pipeline. Under the agreement, Midland could—if it chose—tap the line at a discounted price. Midland used its eminent domain authority to condemn the property. Fifteen property owners challenged the action in a North Carolina state court. The court ruled in Midland’s favor. The owners appealed, claiming that Midland's condemnation was not for public use or benefit, because the town had no concrete plan to tap the line. Therefore, the main issue was...
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