Enginneering Economuy

In: Business and Management

Submitted By Derrick1988
Words 995
Pages 4
Midland Energy resource, Inc. i.

1

Let’s assume that the Midlands borrows its debt at the yield rate of US Treasury Bonds, which is theoretically the minimum choice, and Midlands is going to pay back the debt in a recurring annual payment. We can therefore estimate the amount of annuity that Midland is going to pay back annually. Although we are only going to analyze the single debt option, we should nonetheless keep in mind that Midlands may choose to use a combined debt strategy, which is to borrow both the long-term and short-term debt. Table 1.1 Payment Period Interest Rate Total Net Debt Amount to Pay for Debt/yr 1 yr 10 yrs 30 yrs 4.54% 4.66% 4.98% $80,000 $80,000 $80,000 $83,632 $10,190 $5,192

From table 1.1, we tell that 1-year debt is not a good choice, since about 33% of revenue (i.e. $83K out of $250K) will be used to clear the debt, which will dramatically increase the risk of default. The 10-year and 30-year debts are henceforth both feasible choices, but our suggestion is to choose the 10-year debt so as to reduce the cost of debt. We choose to use 4.66% as the RFR (Rf). ii. Table 2.1 Credit Rating 10-yr US Treasury Spread to Treasury Cost of Debt Consolidated E&P R&M Petrochemicals A+ A+ BBB A4.66% 4.66% 4.66% 4.66% 1.62% 1.60% 1.80% 1.35% 6.28% 6.26% 6.46% 6.01%

Midland Energy resource, Inc.

2

Given that the lower the credit rating is, the riskier the business would be in terms of the danger to default. A normally larger risk premium is added on to Rf for a riskier business (refer to Eq 2.1). Debt rate = Risk-free Rate + Risk Premium

E&P. The most profitable department of Midlands with dominant performance over the industry for the past five consecutive years, the E&P department is the star of the company. With continuously growing demand in the foreseeable future, the performance of this department is unlikely to default the…...

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