1. What is Midland's cost of equity? a. What risk free rate did you use? Why? b....
Question:
1. What is Midland's cost of equity?
a. What risk free rate did you use? Why?
b. Beta? Which should be used? Why?
c. Which Equity Market Risk Premium should we use? Why?
d. What is your estimate of Midland's cost of equity?
2. What is Midland's corporate WACC?
a. Please calculate the debt amount?
b. Cost of debt? Should we assume that it will remain unchanged regardless of the leverage ratio? Why and why not?
c. Please compute the capital structure ratios - D/V and E/V.
d. What do we mean by "capital structure target ratio"?
e. What is Midland's corporate WACC? Which capital ratio, current or target ratio, should we use?
f. Should we always use WACC to compute the cost of capital? Should we use the same WACC for capital projects valuation, asset appraisals and performance evaluation? Should we use different calculations and inputs for different uses? Please provide your team's opinion in details.
3. Midland has a long-term D/E target ratio of 73%. But it is not yet at that target. Assuming Midland plans to shift its capital ratio to the target, does it affect your cost of equity estimate? How does it affect its equity beta? If the equity beta changes as the company moves to the target ratio, what beta should we use to evaluate the future opportunity?
4. Mortensen is calculating different WACCs for each of Midland's operating divisions: Exploration & Production, Refining & Marketing, and Petrochemicals. Is this appropriate?
a. Should Midland need to compute a different WACC for each division? Why and why not?
b. How can we estimate asset betas for divisions?
c. Please estimate divisional WACCs as we did for corporate WACC.
5. How do you explain the difference in the divisional WACCs? To what extent do the different target capital structures explain the variation?
a. Take computed WACC for E&P. And change leverage up and down and recompute WACC. How much E&P's WACC changed across the different leverage ratio assumptions? Please present a sensitivity table.
b. What are the major determinants of WACC based on your analysis?