Midland Energy Resource Inc

2068 Words Feb 28th, 2011 9 Pages
Midland Energy Resources, Inc.
Executive Summary

Midland Energy Resources was fortunate enough to have a skilled financial manager in Mortensen. Her expertise had come to be respected as was evidenced by her promotion and the reliance on her calculations. However, her cost of equity numbers were used as a starting point and manipulated rather than used as presented. Examining the calculation of the firms weighted average cost of capital and betas as well as comparing with others in the same type of industries indicates that assumptions should be changed for the project being analyzed. Consideration of debt, equity, and costs must be given for the specific project while being mindful of company strategy. Although projects may be
…show more content…
There are no shorter term bills to evaluate it in the case. The EMRP that Midland chose was poor because it was much lower than the historical EMRP of the company. The EMRP used is 6.4% because it is both the most recent historical data for US equities and bonds and close to the average for the company for the past 5 years. This differs from the 5% Midland has reduced the EMRP to in more recent years. Please see Q2 in the appendix for calculations.
Since a different calculation options are available for WACC, it is important to consider the hurdle rate utilization. Midland should not use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions. To evaluate most prospective investments, Midland’s DCF methods typically involved a hurdle rate equal to or derived from the WACC for the project or division. The formula for calculating the WACC for each division is:
WACC=r_d (D/V)(1-t)+r_e (E/V)
Each of Midland’s division had its own capital structure, cost of debt and cost of equity. To calculate the cost of debt, Mortensen added a spread over U.S. Treasury securities of similar maturity for each division. The spread depended on a variety of factors, including the division’s cash flow for operations, the collateral value of the division’s assets, and overall credit market conditions. Different division’s operations, long-term expected cash flow and collateral value were different due to the different risk level they each
Open Document