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Midland Energy Resources Case

In: Business and Management

Submitted By whitakertscott
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Question III:
Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?
It depends on what kind of investment opportunity is proposed. If it is an investment that affects the company as a whole on the corporate level then they should use a corporate rate. If it is an investment that applies only to specific divisions then that division’s hurdle rate should be used. Using a corporate rate for division specific investments may incorrectly evaluate the riskiness of a particular investment. The rates should be calculated and used accordingly. The divisions of Midland Energy Resources, Inc. are a bit diverse and therefore any investment opportunities should be separately evaluated based on the division that will be affected.

Question IV:
Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another?
Exploration & Production rE = rf + β(EMRP) rD = rf + E&P treasury spread rE = 4.98% + 1.15(5%) = 10.73% rD = 4.98% + 1.6% = 6.58%

rE = 10.73% rD = 6.58% tax rate = 39%
D/E = 39.8%
D = 39.8
E = 100
V = D + E = 139.8
D/V = 39.8/139.8 = 0.2847
E/V = 100/139.8 = 0.7153
WACC = rD (D/V)(1-t) + rE (E/V) = .0658(.2847)(1-.39) + .1073(.7153)
WACC = 0.08818, 8.818%

Refining & Marketing rE = rf + β(EMRP) rD = rf + R&M treasury spread rE = 4.98% + 1.20(5%) = 10.98% rD = 4.98% + 1.80% = 6.78%

rE = 10.98% rD = 6.78% tax rate = 39%
D/E = 20.3%
D = 20.3
E = 100
V = D + E = 120.3
D/V = 20.3/120.3 = 0.1687
E/V = 100/120.3 = 0.8312
WACC = rD (D/V)(1-t) + rE (E/V) = .0678(.1687)(.61) + .1098(.8312)
WACC = 0.09825%,

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