Midland Energy Resources, Inc.

: Cost of Capital
Case Objectives This case gives you a chance to apply our ideas about cost of capital (WACC) to a real firm with separate divisions. Assignment You are a team of Finance Professionals with experience in analyzing the cost of capital for divisions of companies and companies overall. Janet Mortensen has been struggling with her calculations, wondering if her application is correct given the amount of grumbling she has heard. She has asked you, as experienced professionals, to analyze the company and the current economic data and to assess the cost of capital for the company and one of the companys divisions. Ultimately, she wants to be able to answer to her company and staff: RAVI (1) What is the best way to estimate the company and divisions cost of capital? COST OF CAPITAL (2) Should it be calculated differently for different purposes?COST OF CAPITAL

JAKE WILL COMPILE everyone will send word write-up for their questions You should address your analysis to Ms. Mortensen and support your analysis for the cost of capital for the company and its divisions. WORD DOCUMENT I will play the role of Ms. Mortensen in assessing your analysis. The class members not presenting will play the role of interested staff, employees and board members. (1) Questions to specifically address KARI What is the appropriate risk-free rate to use in the WACC calculations? How did you arrive at this number? COST OF EQUITY

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MARCUS What is the Market Risk Premium (EMRP) that is most appropriate to use in the calculation for the cost of equity? How did you arrive at that number? COST OF EQUITY RAVI What weights for the cost of capital will you use? Answer specifically what weights you will use for your capital components in calculating the cost of capital for the company as a whole. COST OF CAPITAL MARCUS What Beta will you use for your calculation of cost of capital for the company? How did you arrive at that Beta? Are there any adjustments you made to calculation based upon your knowledge? COST OF EQUITY MARCUS What, then, is your cost of equity for the company as a whole? COST OF EQUITY KARI What is the appropriate cost of debt for the company? How did you arrive at this number? COST OF DEBT RAVI Finally, show your calculation for the cost of capital for the company. What rate did you calculate? Does it seem consistent with the case data? COST OF CAPITAL Secondarily, follow up with questions 3-7 above but in relation to the Exploration & Production Division of the company. What rate is appropriate for this divisions cost of capital? What refinements (if any) did you make to arrive at this rate? JAKE COST OF EQUITY (sub-part questions: 4, 5) KARI - COST OF DEBT (sub-part questions: 6) JAKE COST OF CAPITAL(sub-part questions: 3, 7) RAVI will compile everyone will send slides for their questionsPOWERPOINT PRESENTATION
Good morning Team 1Company Presentation Instructions: You will prepare a PowerPoint presentation. Each member must play some role in relaying the data of the case as this is part of your overall assignments grade. You will start with a brief introduction of the company and the current problem Ms. Mortensen is facing. Please use spreadsheet solutions to show how you arrived at calculations. You should address each of the questions in the case, numbered 1-7. You are tasked to cover only the company cost of

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capital and not any divisional costs. You should also answer the 2nd of the in-class discussion questions.

Questions for discussion in class (do not write up) (1) Should the WACCs you calculated be used for all purposes discussed in the case, specifically Mergers & Acquisitions, Capital Budgeting (choosing projects), and Performance Reviews & Compensation? What problems may arise in using the same criteria for all? EVERYONE WILL ADD TALKING POINTS FOR THIS QUESTION AND COMMUNICATE WITH OTHERS Was there other data you wish you would have had for your calculations? Where might you find this data in the real world? Other information 1. Assume the Beta of debt is 0 for comparable companies (not for Midland). 2. Assume the marginal tax rate for the company and all divisions is 40%.

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