Essay about Hbs Case Study

614 Words Jul 2nd, 2012 3 Pages
Midland Resources

1. How are Mortensen’s estimates of Midland’s costs of capital used? How, if at all, should these anticipated uses affect the calculations?

The cost of capital is the minimum acceptable rate of return for new investments in the corporation. Estimates of Midland’s cost of capital are used in many analysis within Midland, including asset appraisal for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. These estimates are used at the divison or the business unit level and also on the corporate level. When asses the cost of capital on different levels of business, managers must invest in new ventures that have an expected rate of return higher than
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Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?

Each division has different business operations which has different risks.

4. Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another?

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

Cost of Debt::

E&P: Rd=4.98%+1.60%=6.5 ,8%

Refining & Marketing: Rd=4.98%+1.80%=6.78%

Cost of Equity:

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 ass`ume 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

Exploration & Production: Re=4.98%+1.15(5%) =10.73%

Defining & Marketing: Re=4.98%+1.20(5%) =10.98%

WACC:

Exploration & Production: WACC=6.58%*46.0 %*( 1-40%) +10.73 %*( 1-46.0%) =7.61%

Refining & Marketing: WACC=6.78%*31.0 %*( 1-40%) +10.98 %*( 1-31.0%)

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