...[pic] Midland Energy Resources, Inc. Cost of Capital Table of Contents I. Executive Summary II. Introduction III. Cost of Capital IV. Risk & Tax Rate V. Capital Structures VI. WACC VII. Conclusion VIII. References I. Executive Summary Midland Energy Resources is a global energy company with operations in oil and gas exploration and production(E&P) providing a broad array of products and services to upstream oil and gas customers worldwide including refining and marketing (R&M), natural gas, and petrochemicals. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources must determine the weighted average cost of capital (WACC) for the company as a whole and each of its divisions as part of the annual capital budgeting process. Various considerations have to be evaluated as risk factors when calculating the cost-of capital. II. Introduction Midland Energy Resources is a leading global energy developer dedicated to providing advanced power systems and energy services around the world. Midland Energy Resources has three divisions Exploration & Production, Refining & Marketing, and Petrochemicals. They have been incorporated more than 120 years previously and they have 80,000 employees in 2007. Exploration & Production business include oil and natural gas exploration and field development and production is there most profitable business with the highest net margin...
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...MIDLAND ENERGY Overview: Midland and Midland’s Divisions: E&P, R&M, and Petrochemicals. Midland Energy Resources Inc. is the global energy company with a broad array of products and services. The company has been in business for over 120 years. The company operates within three different operations: 1. Exploration and Production (E&P) is the most profitable segment. With oil prices at historic highs in 2007, Midland anticipated heavily investment in acquisitions of promising properties. Competition from areas such as the Middle East, Central Asia, Russian and West Africa should be taken into account. 2. Refining and Marketing (R&M) is the largest, however margins had declined steadily over the previous twenty years. 3. Petrochemicals the smallest division. Midland owned 25 manufacturing facilities and 5 research centers around the world. Janet Mortensen, the vise president, has been asked to calculate the weighted average cost of capital (WACC) for each division as well as for the company as a whole. The primary goals of Midland’s financial strategy: * to fund significant overseas growth; * to invest in value – creating projects across all divisions; * to optimize its capital structure; and * to opportunistically repurchase undervalued shares. Janet Mortensen’s estimates of cost of capital were used for the following analysis: * Asset appraisal – asset valuation * Capital Budgeting – DCF, NPV and allocation of...
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...Midland Energy Midland Energy Resources Inc.: Cost Of Capital Introduction Midland Energy Resources have a senior vice president, Janet Mortension, of project finance. She was preparing her annual cost of capital for midland as well as for each of its following three divisions: * Exploration & production (E&P) * Refining & Marketing (R&M) * Petrochemicals Midland was a global company with operations in oil and gas. Midland corporate treasury had began analysis and preparation of annual cost of capital for the corporation as a whole and for each divisions as part of annual capital budgeting process but this estimates were often criticized, and Midland division presidents and controllers sometimes challenged specific assumptions and inputs. The case uses comparable companies to estimate asset and beta for each individual division, and must comply the capital asset pricing model for calculating the cost of capital. Midland was conservative compared to some of its large competitors, but it has a group of trader in- house who actively managed currency. Interest rate and commodity risks within a set of guideline approved by the Board. Midland Energy Resources ha d been incorporated more than 120 years previously and in 2007 had more than 80,000 employees. Midland’s financial strategy in 2007 was founded on the following four pillars: * Oversees Growth * Value- Creating Investment * Optimal capital structure * Stock Repurchases Oversees Growth: Oversees investment were...
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...QUESTIONS FOR THE OVERALL ASSIGNMENT 1. What is the best way to estimate the company and divisions’ cost of capital? Answer: The best way to estimate the cost of capital is by using the CAPM (Capital Asset Pricing Model) where the Weighted-Average Cost of Capital (rwacc) is given by the formula [pic] Where, D is the market value of the net debt E is the market value of the total equity V is the total market value of debt and equity = D + E T is the corporate tax rate rd is the appropriately calculated discount rate for debt (cost of debt) re is the appropriately calculated discount rate for equity (cost of equity) The cost of capital (rwacc) for the company can be calculated from the observable market values of debt (D), equity (E), & corporate tax rate (T) and calculated discount rate for debt (rd) & discount rate for equity (re). The market values of debt can be estimated from the company’s current amount of debt, their maturity levels, and credit rating and by utilizing the risk-free rate that can be observed in the market. The market value of equity can be estimated from multiplying the total number of outstanding shares and the company’s stock-price. The discount rate for debt can be calculated from on market value of debt and credit rating for the company’s debt, which includes adjustments for the company debt’s default risk. The discount rate for equity can be calculated from estimated...
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...Midland Energy Resource Report for Cost of Capital October 16, 2014 Abstraction General Analysis of Midland Energy Resources Cost of Debt • • • • Consolidated Company Exploration & Production Refining and Marketing Petrochemicals Cost of Equity Equity market risk premium of 5% is reasonable. According to the Exhibit 6, the U.S. stock return minus Treasury bond yields for each period varies. Since each period has different standard error, it will be better to take the weighted average of the data, then EMRP is approximately 5.9% or lets say 6.0%. Comparing to the EMRP that Midland would use in the calculation of WACC which is 5%, the historical data reflects a higher EMRP. But from the market risk premium survey results, we see that finance professors, CFOs and fund managers advocate a lower rate on risk premium. Because these people have better understanding in the performance of the market and be more aware of how economics works, then the analysis from them should be taken into great consideration. Therefore, 6.0% from the past data balanced with some lower rates that suggested by bankers, auditors as well as Wall Street analysts, 5% should be appropriate. Weighted Average Cost of Capital WACC = λ(1 − t)KD + (1 − λ)KE The Effect of Leverage on the Cost of Equity and WACC Cost of Equity The relation between cost of equity and leverage can be shown as follows: βEquity = 1 βU (1 − λ) Asset Cost of Equity = Risk Free Rate + βEquity × (Risk Premium) We further illustrate...
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...Executive Summary: Midland Energy Resources, Inc. is a global energy company with a broad array of products and services. The company operates within three different operations including oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Midland has proven to be a very profitable company, with reported operating revenue of $248.5 billion and operating income of $42.2 billion. The company has been in business for over 120 years and employed more than 80,000 individuals. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources, has been asked to calculate the weighted average cost of capital (WACC) for the company as a whole, as well as each of its three divisions as part of an annual budgeting process. Midland’s Three Divisions: Exploration & Production Oil exploration and production (E&P) is Midland’s most profitable business, and its net margin over the previous five years was among the highest in the industry. With oil prices at historic highs in early 2007, Midland anticipated heavy investment in acquisitions of promising properties, in development of its proved undeveloped reserves, and in expanding production. They also needed to account for competition from areas such as the Middle East, Central Asia, Russia, and West Africa. Refining and Marketing Midland had ownership interests in forty refineries around the world with distillation capacity of five million barrels a day....
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...Executive Summary Midland Energy Resources is a leading global energy developer dedicated to providing advanced power systems and energy services around the world. Midland Energy Resources has three divisions Exploration & Production, Refining & Marketing, and Petrochemicals. They have been incorporated more than 120 years previously and they have 80,000 employees in 2007. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources must determine the weighted average cost of capital (WACC) for the company as a whole and each of its divisions as part of the annual capital budgeting process. As each division has different functions and risk associations, the company needs separate discount rate to evaluate its projects. This report is prepared to find out the realistic measures for assessing cost of capital for Midland Energy Resources. After careful evaluation of available information and using finance literature and relevant course lectures, the analysis is prepared to offer appropriate recommendations for Midland Energy Resources to make future capital budgeting decisions. Company Overview Midland Energy Resources is a global energy company with operations in oil and gas exploration and production (E&P) providing a broad array of products and services to upstream oil and gas customers worldwide including refining and marketing (R&M), natural gas, and petrochemicals. Exploration & Production business, including oil and natural gas exploration and...
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...Midland Energy Resources, Inc.: Cost of Capital Executive Summary Midland Energy Resources, Inc. is a global energy company comprised of three different operations – oil and gas exploration (E&P), refining and marketing (R&M), and petrochemicals. E&P is Midland’s most profitable business, and midland anticipated continued heavy investment in acquisitions of promising properties, in development of its proved undeveloped reserves, and in expanding production. Midland wanted to boost investment in sophisticated extraction methods, and capital spending in E&P was expected to exceed $8 billion in 2007 and 2008. R&M is Midland’s largest division, measured my revenue. The relatively small margin was consistent with a long-term trend in the industry, and Midland projected capital spending in R&M would remain stable. Petrochemicals is Midland’s smallest but most promising division. Capital spending in petrochemicals was expected to grow in the near term. Much of the new investment would be undertaken my joint ventures outside US. The primary goals of Midland’s financial strategy are to fund substantial overseas growth, invest in value-creating projects, optimize capital structure, and repurchase undervalued shares. To achieve these goals, Midland must calculate an appropriate cost of capital that will allow reasonable valuations of their strategies. Janet Mortensen, the senior vice president of project finance for Midland Energy Resources, has been asked to...
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...To: Janet Mortensen, CFO From: Senior Financial Analyst Division Date: October 7, 2013 Re: Midland Energy Resources Inc. Weighted Average Cost of Capital Midland Energy Resources Inc. is a publicly traded company that primarily deals in the energy industry. The company itself is divided into three major operational divisions, two of which that is concerning to the company include: Oil and Gas Exploration and Production (E&P) and Refining and Marketing (R&M). The Petrochemicals division will not be addressed. Going forward, Midland Energy would like to undertake various development projects and property acquisitions, and the profitability of such endeavors must be evaluated. To do so, both the single corporate and the two division WACCs must be calculated. Management team at Midland Energy Resources Inc. can determine which of the three appropriate WACC figures to be used for future company reports. In order to calculate Midland Energy Resources’ corporate WACC, the calculations are based on the formula below, where ������������ and ������������ are the cost of equity and debt respectively, D and E are the values of debt and equity respectively, V is the company’s enterprise value, and t is the tax rate. WACC estimates for the company as a whole and for each division are summarized in Table 1. How it is arrived at these figures is shown in the calculations in Appendix 1 and the decisions for each variable are explained below. ������ ������ ������������������������ = ������������...
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...Message Our team has performed thorough analysis surrounding the questions of cost of capital for Midland Energy Resources, Inc. (Midland). Here are the results of our research: 1. Ms. Mortensen estimates Midland’s cost of capital for a variety of reasons including use for capital budgeting, financial accounting, performance assessments, stock repurchase estimations, and potential “M&A” opportunities. In addition, Midland relies on the cost of capital to deliver on the financial and investment policies set forth by the Board. Finally, the cost of capital is also used in relation to expected growth and forecasted demand. To explain, if the forecasting department foresees an increase in sales of resources, Ms. Mortensen can use the cost of capital to properly determine if it is financially sound to make an investment in the company to support that demand. Should Ms. Mortensen overestimate the cost of capital for the firm, Midland may miss out on investment opportunities and will under value the investment at hand. Furthermore, it is possible for shareholders to see a lower return on their investment. At the other end, in which the cost of capital is understated, Midland may engage in an investment that is potentially “bad” and will be overvalued. Shareholders will see over inflated returns based on this approach. 2. Based on our calculations, our team has determined that Midland’s firm-wide WACC is 8.48%. Assumptions that our team made can be found starting...
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...Índice Midland Energy Resources, Inc. 3 Exploración y Producción de Hidrocarburos 3 Refinación y Comercialización 3 Petroquímica 3 Problemática del Caso 3 Solución 4 Escenario 1 5 Supuestos: 5 Cálculo: 5 Escenario 2 5 Supuestos: 5 Calculo: 6 Conclusiones y Recomendaciones 6 Midland Energy Resources, Inc. Midland Energy Resources, es una compañía global de energía con operaciones en exploración y producción de petróleo & gas (E&P), refinación y comercialización (R&M) y petroquímica (P). En 2006, la empresa obtuvo ingresos y utilidades operacionales por $248.5 y $42.2 mil millones de dólares. Esta empresa tiene 120 años en el mercado y opera con más de 80,000 empleados. Exploración y Producción de Hidrocarburos Durante 2006, Midland extrajo 2.10 millones de barriles de petróleo por día, lo que representa un incremento del 6.3% con respecto al 2005 y cerca de 7.28 mil millones de pies cúbicos de gas natural por día, con apenas un incremento del 1% con respecto al 2005. Con estos precios en su nivel record, Midland anticipa seguir invirtiendo en propiedades prometedoras para el incremento de su producción. Refinación y Comercialización Midland es propietario de 40 refinerías en el mundo con una capacidad de refinación de 5.0 millones de barriles por día. Sus ingresos en el 2006 fueron de $203.0 mil millones, 1.8% por debajo del 2005 y un resultado, después de impuestos, de $4.0 mil millones. Midland proyectó que la inversión en esta...
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...We can compute the cost of equity by using the CAPM model: [pic] In order to solve this equation, we need to fine beta and EMRP. Midland’s beta was available on the case, which is 1.25. And Midland chose to use an equity market risk premium(EMRP) of 5.0% after a review of recent research and in consultation with its professional advisors. So, [pic] Using the following formula, we can calculate average asset beta for each comparable companies and the required two divisions: [pic] [pic] is close to zero so the equation becomes: [pic] Then we can get, Jackson Energy,Inc: [pic] Wide Plain Petroleum: [pic] Corsicana Energy Corp: [pic] Worthington Petroleum: [pic] Average for E&P: [pic] Bexar Energy, Inc: [pic] Kirk Corp: [pic] White Point Energy: [pic] Petrarch Fuel Services: [pic] Arkana Petroleum Corp: [pic] Beaumont Energy, Inc: [pic] Dameron Fuel Services: [pic] Average for R&M: [pic] Now we can use the results above and the respective capital structures as provided in Table 1 about the E&P and R&M divisions to estimate the their equity beta, cost of equity and WACC. As listed in Table 1, Debt/values(V=D+E) of Exploration & Production and Refining & Marketing are 46% and 31.0% respectively, and The calculation to fine Equity Beta is: [pic] So Equity beta for E & P division is [pic]; Equity beta for R & M division is [pic]. Then we still need the CAMP method to calculate cost of equity([pic]). So, [pic] From the calculation before we know...
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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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...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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