The Cost Of Capital Is Calculated For Midland On A Firm Wide And Divisional Level

General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.

The too high estimated cost of capital means that Midland may miss out on investment opportunities and will under value the investment at hand. Furthermore, it is possible for shareholders to see a lower return on their investment. On the other hand, a too low estimated cost of capital

Assumptions need to be made for the Cost of Equity. We used the corporate rate of 11.766%

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

We use Capital Asset Pricing Model (CAPM) approach to calculate the cost of equity. The formula of CAPM is re = rf + β × (E[RMkt] – rf).

A correct response requires that you find an appropriate industry beta and measure for levered/unlevered betas and requires that you define cost of equity capital and free cash flow (FCF) – you may need a formula for FCF.

The cost of equity was found using CAPM, with the given market risk premium of 5%, a beta of .88, and risk-free rate of 4.03%. The beta was found by running a regression of Southwest’s percent change in stock price versus the S&P 500’s percent change in stock price for two years (June 28, 2000 to June 28, 2002). The risk-free rate was the return on a ten-year treasury note issued on June 28, 2002, according to the U.S. Treasury’s website. The tax rate of 39% was used to account for tax savings from leverage. In order to calculate the firm’s leverage, the market value of equity was found from the price per share on July 24, 2002 (Yahoo Finance) and the shares outstanding on the balance sheet of the July 10-Q report, as shown in Exhibit X. The debt value was approximated at the book value since data could not be found regarding its market value. This analysis resulted in a debt weight of 11.74% and equity weight of 88.26%. The final approximation for the weighted average cost of capital was 8.64%.

The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).

To find the cost of equity we used the formula rs = rRF + beta*MRP in which rRF2002 = 5.86% and the Market Risk Premium (MRP) = 5% as calculated by the Southwest Airlines finance department. We then calculated the beta for Southwest Airlines based on a regression analysis of five-year monthly returns on Southwest stock from January 1997 to January 2002, compared with the S&P 500 returns over the same period. This regression analysis indicated that Beta = .2219. Therefore,

Lastly, the interest rate was calculated by dividing interest expense by long-term debt for the company. These numbers, along with equity and debt data given to us in the case, resulted in a WACC of 13.89%.

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

The following case analysis portraits the use of capital asset pricing model to compute the weighted average cost of capital for Marriott and each of its divisions. The flow of events below is following a string of different evaluations, each of which is assessed separately.

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:

company’s securities, both debt and equity. The WACC is important to calculate because it is a necessary

As long-term valuation is assumed, risk free rate is set as 30-year treasury rate, 5.73%. Cost of debt is 6.72% reflecting Amoco’s credit level. Cost of equity is calculated as 10.63%, leading to final WACC at 8.85% (Chart 1).