Memorandum
To: Ms. Mortensen
CC: Prof. Bjorn Johnson
Date: 02/25/2013
Subject: Midland Energy Resources, Inc. Analysis

Janet Mortensen, senior vice president of project finance for Midland Energy Resources, needs to estimate the cost of capital because it is an important data for estimating the project whether it will be profitable and worth the resources and risk. As mentioned in the case, Midland estimates the cost of capital to be used in analyzing asset appraisals for capital budgeting and financial accounting, performance assessments, M&A proposals, stock repurchase decisions. Some of these analyses were performed at the division or business unit level, while others were at the firm wide level.
A too high estimate of the cost of capital may lead to an under-estimate of the present value of return in the project. So it might result in under-estimate of the NPV of the whole project. On the contrary, a too low estimate of the cost of capital would result in an over-estimate of the NPV. Both over-estimate and under-estimate would affect the company to make the best decision of the project.
Midland’s firm-wide, E&P, and R&M WACC

Retrieved from excel, above are Midland’s firm-wide, E&P, and R&M WACC. The method and choices of inputs will be explained as follows, also excel sheet attached.
For cost of debt, the formula used is Rd = Rf + Spread to Treasury. Assume that Midland will continue heavy investment in long term because of global population and economic growth resulting in rising demand of its product, and a longer-term global shortage of refining capacity that would also motivate the investment, 30-year yields to maturity for U.S Treasury bonds of 4.98%(Rf) is used for both divisions and in the firm wide. The spread to treasury for Consolidated, E&P, and R&M are given in Table 1: 1.62%, 1.60%, and 1.80%, respectively.