The Midland Energy Resources Case

下面为大家整理一篇优秀的assignment代写范文- The Midland Energy Resources Case，供大家参考学习，这篇论文讨论了米德兰。米德兰是一家全球知名的能源企业，拥有120多年的历史和8万名员工，是一家美国上市公司，主要业务包括石油和天然气勘探和生产、炼油和标记和石油化工。米德兰以资源为导向，拥有强大的勘探设备、丰富的油气储量、先进的生产技术和广阔的全球市场，它的大部分利润来自于勘探开发部门，而研发部门占了它收入的很大一部分。

A well-known global energy enterprise with a long history of over 120 years and 80,000 employees, Midland is a US public company whose primary businesses include oil and gas exploration and production (E&P), refining and marking (R&M), and petrochemicals. Midland is resource-oriented as it owns powerful exploration equipment, abundant oil and gas reserves, advanced production technology, and broad markets around the world; most of its profits are generated from the E&P segment while the R&M segment accounts for a large part of its revenue. However, Midland does have its disadvantages as do similar energy companies. Midland’s profitability and even its survival are highly susceptible to international political environment and natural factors; for example, even slight regional political conflicts may interfere the trading of

Midland’s products and services and threaten the company’s stability. This drawback partly justifies Midland’s ambition to expand overseas market, seek value–creating projects, and – most importantly – defend its capital structure.

The responsibility of optimizing Midland’s capital structure falls upon Mortensen, Midland’s senior vice president of project finance. Before Mortensen joined Midland’s finance department, previous treasury staff seemed unable to bring out satisfied financial strategy to the management; either the staff could not judge the appropriateness of making financial budgets on a division base or at corporate level, or these people had problem in understanding some of the assumptions and inputs underlying their financial model. Mortensen’s participation was to address these uncertainties and to carry out a feasible solution to the company’s capital structure issue.

Mortensen, along with her team, finally adapted the Weighted Average Cost of Capital method (WACC) to analyze Midland’s capital arrangements. Briefly speaking, Mortensen follows the principles below when performing her capital structure calculation:

1. Use the classical WACC model;

2. Compute data on a division basis rather than on a company (as a whole) basis;

3. Use figures from publicly available data sources as an approximation when values for specific variables are unobservable. (Note: This principle may give rise to comparability problem.)

B. A Group of Core Concepts: Cost of Capital, WACC, and CAPM

The above three concepts are the pillar of establishing a rigorous capital cost model and must be interpreted primarily.

1. Cost of Capital

Cost of capital can be considered the monetary expenses a company has to pay when

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it uses money from different owners to facilitate its own business. Ideally, if a company were able to run its business by entirely using its OWN capital, then its cost of capital could be thought of as zero (of course, we ignore opportunity cost here) because it did not owe anyone anything. But actually, very few companies do so. Remember, money is a type of commodity with a price, which is the cost of using it – or, say, the return that must be paid back to people who at the beginning contributed this amount of money to the company in the form of interest payments or dividends.

Usually, a company finances its operation via two ways: Borrow money from someone (debt financing) or solicit people to invest in the company where both parties share returns and undertake risks together (equity financing); correspondingly, cost of capital can be divided into cost of debt and cost of equity.

2. WACC

WACC stands for Weighted Average Cost of Capital. It is used to measure the whole cost of capital a company has to bear; it defines this aggregate capital cost as the sum of market-value-weighted average of the cost of debt and that of equity. In other words, it assumes a company’s capital expenditure consists of only debt cost and equity cost. WACC is mathematically expressed below:

WACC = ( ) (1 −  ) + ( ), where:

rd = cost of debt;

D = market value of debt;

t = official tax rate (usually the federal tax rate); re = cost of equity;

E = market value of equity.

3. CAPM

CAPM stands for Capital Asset Pricing Model, a model used to estimate the cost of equity. It starts with the risk-free return of US Treasury Bond, uses average return of the broad market as a benchmark, and combines the sensibility of the company to market volatility to reach the cost of issuing stocks to potential shareholders. Note, when calculating CAPM, Mortensen mainly refers to data from public sources.

CAPM is mathematically expressed below:

re = rf + β[E(rm) – rf],where: rf = risk-free return of US Treasury Bond;

β= units of movement of the company’s stock price given one unit of movement of the whole market;

rm = average return of the broad market, used as the benchmark.

*4(Additional). Cost of Debt

In Midland’s case, the calculation of cost of debt is simpler. Mortensen used the rate of US Treasury Bonds as a benchmark and gave each of Midland’s divisions a premium to the basic riskless rate (called a spread). For example, we can see from Table 1 that Mortensen allots a 1.62% spread to Midland as a whole and 1.60%,

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1.80%, and 1.35% to E&P, R&M, and Petrochemicals, respectively.

5. Summary

As can be seen above, CAPM, cost of debt, and WACC are an inseparable entirety in evaluating a company’s cost of raising money to run its business. A relationship cart can be drawn below:

WACC = ( ) (1 − ) + ( )

Calculable by using spread Calculable by CAPM

C. Calculation

We use cost of capital to evaluate Midland’s overall financing cost. Mortensen’s estimates are used to assess the safety and efficiency of Midland’s capital structure; plus, Mortensen’s results are also compared with each division’s predetermined target ratio to see if there is a significant deviation from the benchmark. Of course, given the ever changing market environment, targets themselves need to be adjusted frequently. For example, during market bullishness in 2007, debt ratio could be raised aggressively to make intelligent use of tax shielding; in times of market bearishness, debt financing ought to be conservative to avoid default.

Below we perform a series of calculations to get a clearer picture of Midland.

1. Midland’s Corporate WACC

Inputs Symbol Description Value

Debt ratio D/V Given in Table1, where debt/value ratio is 42.20%

42.2% for Midland as a whole.

Equity ratio E/V E/V = 1 – D/V = 100% – 42.2% 57.80%

Midland’s spread to treasury is 1.62%, given in

Table2. Table2 presents interest rates for US T-

Cost of debt rd Bonds of different maturities. Considering 6.28%

energy companies conventionally need 10-15

years to finish their capital projects, we pick the

10-year rate (4.66%) as benchmark.

Use CAPM. Risk-free rate is T-Bonds’ 10-year

rate, 4.66%; Midland’s overall beta is 1.25; and

Cost of equity re EMRP is 5%.  10.91%

Note: Since Midland’s common shares are

publicly traded, Midland’s beta is considered

accurate. 

Tax rate t Based on income data shown in Exhibit1, we 38.60%

calculated Midland’s 2006 tax rate to be

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taxes/EBT.

Midland’s corporate WACC = 6.28%×42.2%×（1 – 38.6%）+10.91%×57.8%= 7.93%

2. Petrochemicals Division’s WACC

Using similar logic, we can compute Petrochemicals Division’s WACC. A list of necessary inputs is shown below:

Inputs Symbol Description Value

Debt ratio D/V See Table1. 40.00%

Equity ratio E/V E/V = 1 – D/V = 100% – 40.0% 60.00%

Petrochemical Division’s spread to treasury is

Cost of debt rd 1.35%, given in Table2. Also use 10-year T- 6.01%

Bond rate as benchmark.

Use CAPM. Risk-free rate is T-Bonds’ 10-year

rate, 4.66%; Petrochemical Division’s beta is

Cost of equity re 1.40 given that this division’s expansion 13.62%

strategy is more aggressive; and EMRP is set at

6.4% (using data in Exhibit 6).

See Exhibit3 and use 2006 data. Tax rate = 1 –

Tax rate t After-tax earnings/EBT = 1 – 90.50%

2097 

= 90.5%. 

23189−436−642 

Petrochemical’s WACC = 6.01%×40.0%×（1 – 90.5%）+13.62%×60.0%= 8.40%

D. Further discussions

1. Should Midland compute different WACC for each division?

It is recommended that Midland compute an individual WACC for each division because Midland’s three divisions each have different operating profiles.

For example, E&P is a large, lucrative and relatively stable department whose revenue and profit margin are the highest among industry. Thus, the best choice may be to remain status quo; debt financing may account for a larger proportion in its capital structure. Similar strategy is suitable for R&M, where substantial growth is not projected and market remains stable. However, the Petrochemical division is confronted with a different situation because it is the smallest division and is expected to experience rapid expansion abroad. So, equity financing should be the main source of operating capital in order to avoid the danger of default.

2. How can we get asset betas for EACH division?

Since Midland’s divisions do not have publicly traded shares, readily available betas precisely covering the risk and return profile of each division do not exist. The only

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way is to estimate betas for each division on a comparable-companies basis.

As in the case, Exhibit5 gives a list of valuation data for comparable companies and divisions within the industry; we can use these numbers as an acceptable approximation of the real situation of the to-be-analyzed objects after necessary adjustments are made. For instance, one possible way is to remove abnormal values (ultra-high or ultra-low values) in a series and compute the average level of the rest.

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