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
Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted
This course applies corporate finance concepts to make management decisions. Students learn methods to evaluate financial alternatives and create financial plans. Other topics include cash flows, business valuation, working capital, capital budgets, and long-term financing.
Assignment summary: You are taking the role of a security analyst who recently started following the Oil and Gas industry. The analyst has a task to draw a comparison of several financial indicators for two industry leaders: Exxon Mobil and Royal Dutch Shell, based on their income statements and balance sheets (attached at the end of this document) as well as the information from the notes to the financial
Analyze the fundamental differences between the working capital structures and components for each chosen company, and speculate upon the main reasons why such differences exist.
We determine the amount of capital financing needed by taking line (10), after-tax net income and adding back line (16) depreciation, to determine actual capital needed given the forecast of capital expenditure. We made certain assumptions, such as, cash levels will be kept roughly in line with 1983 level of $542 million. In addition, we assumed that tax provisions were actually paid out each year, rather than accruing a liability or deferring taxes to future dates. According to our assumptions and using the forecast we have determined that MCI needs approximately $4.2 billion dollars in the next 4 years, from 1984 through 1987. After 1987 capital expenditure begins to taper off and growth in EBITDA increases to a point where it is enough to finance internally the planned capital expenditures. Over 75% of the capital requirements comes in the later 2 years, in 1986 and 1987.
Two managers attending an executive education course attempt to develop a cost of capital estimate for a leading telecommunications company, Telus The two managers are somewhat confused about the costs of various sources of capital, the calculation of the overall cost of capital and the appropriate use of the hurdle rate
At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable
Penn Oil Corporation has two divisions, Refining and Production. The company 's primary product is Luboil Oil. Each division 's costs are provided below:
4. Consider the Worldcom-MCI merger and the Qwest-US West merger. Trying to avoid hindsight bias, should the board of MCI and US West have accepted these offers? What is the obligation to shareholders? Was that obligation fulfilled? What about WorldCom and Qwest? Did their shareholders benefit?
Cost of Equity is the return that stockholders require for a company. A company’s cost of equity represents the compensation that the market demands in exchange for owning the assets and bearing the risk of ownership. Based on capital markets the cost of equity varies in direct relation to the assumed risk in that specific market. The distinctive of the firm is the sensitivity to market risk (β) which depends on everything from management to its business and capital structure. Therefore past performances and present conditions have a direct effect on the overall value. Applying calculations at a divisional level allows specified markets to be analysis based on present market conditions for that service or product. The formula used to calculate Cost of Equity is:
I do not think it is proper. Since hurdle rate is the key factor to determine whether we should accept a project, it is concerned with a specific investment opportunity belonging to a division. As we can see in Table 1, each of Midland`s divisions had its own target debt ratio. Those
Hurdle rates, the weighted cost of capital that projected cash flows must exceed for initiatives to be considered, vary within Marriott Corporations due to their unique industry risk levels and capital structures. They use this number to determine which projects to accept, to adjust the rate at which the firm grows and as a measure for compensation within each business area, and as incentive compensation.
Helen also goes on to explain that if one segment’s hurdle rate is lower than the corporate hurdle rate, the company would be destroying shareholder value. The whole is a sum of its parts. What if Teletech has the opportunity to invest in a project that creates value at a hurdle rate below the firm wide 10.41%, but above the segment’s hurdle rate? This investment would create value in this segment, but in the strategy of one hurdle rate, the project would be overlooked.
* Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3.
As indicated by the case study S&P 500 index was use as a measure of the total return for the stock market. Our standard deviation of the total return was used as a one measure of the risk of an individual stock. Also betas for individual stocks are determined by simple linear regression. The variables were: total return for the stock as the dependent variable and independent variable is the total return for the stock. Since the descriptive statistics were a lot, only the necessary data was selected (below table.)