We can compute the cost of equity by using the CAPM model:
[pic]
In order to solve this equation, we need to fine beta and EMRP. Midland’s beta was available on the case, which is 1.25. And Midland chose to use an equity market risk premium(EMRP) of 5.0% after a review of recent research and in consultation with its professional advisors. So,
[pic]
Using the following formula, we can calculate average asset beta for each comparable companies and the required two divisions:

[pic]
[pic] is close to zero so the equation becomes:
[pic]
Then we can get, Jackson Energy,Inc:
[pic]
Wide Plain Petroleum:
[pic]
Corsicana Energy Corp:
[pic]
Worthington Petroleum:
[pic]
Average for E&P:
[pic]

Bexar Energy, Inc:
[pic]
Kirk Corp:
[pic]
White Point Energy:
[pic]
Petrarch Fuel Services:
[pic]
Arkana Petroleum Corp:
[pic]
Beaumont Energy, Inc:
[pic]
Dameron Fuel Services:
[pic]
Average for R&M:
[pic]
Now we can use the results above and the respective capital structures as provided in Table 1 about the E&P and R&M divisions to estimate the their equity beta, cost of equity and WACC. As listed in Table 1, Debt/values(V=D+E) of Exploration & Production and Refining & Marketing are 46% and 31.0% respectively, and The calculation to fine Equity Beta is:
[pic]
So Equity beta for E & P division is [pic]; Equity beta for R & M division is [pic]. Then we still need the CAMP method to calculate cost of equity([pic]). So,
[pic]
From the calculation before we know that:
[pic]
The tax rate is 39.73%. As to E&P division, from the data that D/V=46.0% we can easily get that E/V=54%. For R&M, E/V=69%. Again the our calculation will be based on the formula shown below:
[pic]
[pic]
[pic]
WACC(Weighted Average Cost of Capital) tells us the minimum rate of return at which a company produces value for its investors. If the company’s return is more than WACC