Midland Energy Resources

c. SDI’s officers have been under pressure from the board of directors to do something to improve the price of the common stock. Management is also concerned about the stock price personally because bonuses are based on the performance of SDI’s stock price relative to other firms in its industry. So, they would like a detailed explanation of how the market price is determined—what do investors look for, and what can management do to provide what investors want? Bob Wilkes also wants you to explain how stock valuation information be used to help estimate the company’s cost of equity. Tony Biddle provided some information that can be used in the stock valuation process. First, as background on what investors think about the company, here are some representative quotations taken from analysts’ reports issued during the past few years.

I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.

WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity

To calculate the cost of debt and equity for this project, we combined the risk-free rate with a risk premium based on the market risk premium and the riskiness of Southwest Airlines.

In Part 5 we can summarize our calculations for WACC. Table 1.2 shows our WACC.

e.g. For Universal Mobile this value is computed as follows (we are using the tax rate as 40%)

Repeat Steps 3 and 4 for the two scenarios you would like to analyze, issuing $1 billion in debt to repurchase stock, and issuing $1 billion in stock to repurchase debt. (Although you realize that the cost of debt capital rD may change with changes in leverage, for these modestly small changes you decide to assume that rD remains constant. We will explore the relation between changing

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

In addition, this value was adjusted downward to 1.09 to account for drift (Table 3). The market risk premium, 5.20%, was derived from a historical implied premium (FCFE) as the 10-year average. Following the application of CAPM, the cost of equity was computed to be 7.94%. In order to extract LUVs 3.47% cost of debt, we capitalized and discounted all outstanding debt instruments at their respective spot rate. Following the application of Southwest’s forecasted marginal tax rate of 38% and target capital structure of 70% equity and 30% debt, WACC was computed as 6.20%.

Tax rate in last five year are slightly different. So assume the 2014 tax rate 32.9% is the new run rate.

It is determined that the company worth is $856,518 with a share price of $351.03 per value as per the discounting dividend cash flow valuation approach..In appraising the anticipated premerger performance of the company, the weighted average cost of capital is computed; the worth of the WACC for FVC is 9.2% as depicted in

D The firm is asking the finance department of FarWest for an estimate of its cost of capital. FarWest can borrow long term at 7%; its corporate tax rate is 40%. Its beta coefficient is 1.05. The rate of interest on government bonds is currently 5.2%, and the market risk

Using CAPM the required return on equity and the cost of equity is 18.05%. With an after tax cost of debt of 5.85%, WACC is 13.78%

So, for this problem we need to find the WACC which can be found by the formula (Wd)*(Rd)*(1-T)+(Wps)*(Rps)+(Wce)(Rs)... We are again given most of the values, so it’s plug-and-chug from here on, pretty much. Debt is 0.30, PS is 0.05, Equity is 0.65, Rd is 0.06, T is 0.40, Rps is 0.058, and Rs is 0.12... So when plugged it looks like: (0.30*0.06*(1-0.40))+0.05*0.058+0.65*0.12, and that came out to 9.17

One of the two major component of WACC is the cost of equity. The cost of equity model takes into account three values which we must calculate - a risk-free rate (rf), risk premium rate (expected market return - rf), and Beta Value.