Midland: Cost and Equity Market Risk Essay

Decent Essays

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

Mortensen’s cost of capital estimates are used for a variety of purposes at both the divisional and corporate levels. Examples include internal analyses such as financial accounting, performance assessment and capital budgeting, while others are used for strategic planning purposes such as merger and acquisition, as well as stock repurchase decisions (Luehrman and Heilprin, 2009, pg.1). When used at the divisional rather than corporate level, special consideration should be given to the fact that Midland’s divisions are not publicly traded entities, and therefore do not have individual Beta …show more content…

This implies an increase in standard error and deviation from the correct estimation.

3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why of why not?

Midland should not rely on a single corporate hurdle rate for evaluating investment opportunities across all divisions because each division is subject to fundamentally different forces such as political volatility, and high future expenditures. For example, R&E is expected to have capital expenditures in excess of $8 billion over the years 2007 and 2008 while worldwide refining capabilities are expected to decrease leading to possible investments in this division of Midland. The Exploration and Production division faces an entirely different set of challenges as oil reserves become more difficult to reach as in the case of arctic and deep water drilling operations, and consequently more expensive to exploit. In addition, political instability has become increasingly prevalent in investment considerations as oil production in areas such as the Middle East and Africa have grown. Civil and political upheaval in these regions threatens disruption of oil production and lead to greater volatility of prices (pg.2).

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

The cost of capital

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