$1.$ How are Mortensen$$s estimates of Midland$$s cost of capital used?

$2.$ Estimate the Cost of Equity using both CAPM and the Dividend Discount Model. Compare the results.

$($Under the Dividend Discount Model, you estimate the cost of equity $($Ks$)$ as

Ks $=$ DIV$1/$P$0+$ g$,$ where DIV$1$is the expected dividend next year, P$0$ is the current stock price, and g is the expected constant growth rate of future dividends.$)$

$3.$ Calculate Midland$$s corporate WACC. Be prepared to defend your specific assumptions about the various inputs to the calculation. Is Midland$$s choice of EMRP $($Expected Market Risk Premium$)$ appropriate? How about their choice of risk free rate? If not, what recommendations would you make and why?

A$.$ First, rearrange the balance sheet, so that only debt and equity remain on the liabilities side of the balance sheet.

To accomplish this,

i$)$ compute Net Working Capital as $($Notes Receivable $+$ Inventories $+$ Prepaid Expenses$)($Accounts Payable and Accrued Liabilities $+$ Taxes Payable$)$

ii$)$ compute Net Fixed Assets as $($Investments & Advances$+$ Net Property, Plant & Equipment$+$ Other Assets$)($Post Retirement Benefit Obligations$+$ Accrued Liabilities$+$ Deferred Taxes$+$ Other Long Term Liabilities$)$

iii$)$ compute Net Debt as $($Current Portion of Long Term Debt$+$ Long Term Debt$)($Cash & Cash equivalents $+$ Restricted Cash$)$

The above steps should leave Net Working Capital and Net Fixed Assets on the asset side and Net Debt and Equity on the liabilities side; the debt and equity securities will be entitled to the cash flows generated by the firm.

B$.$ WACC should be based on debt and equity proportions used by the firm going forward; use the debt and equity values for Midland Energy in Exhibit $5.$

$4.$ Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why or why not?

$5.$ Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another? $($For example, how did you get the asset beta for each division?$)$