Midland - a Global Energy Company

...

After this, I am going to compute separate cost of capital for the E&P and M&R divisions and discuss the difference between these two. E&P Re = Rf + β(EMRP)Re = 4.98% + 1.15 (5%) = 10.73% Rd = Rf + E&P Spread to Treasury Rd = 4.98% + 1.60% = 6.58% By using the formula the answer of WACC for E&P is 8.82%. Using the same way we can get the WACC for E&P is 9.83%. The difference is quite obvious just because these two business units run in the different industries. Therefore, these two business have different risk preferences, βs and credit ratings.

Last question is to compute the cost of capital for the Petrochemical division. In order to get a more accurate data of β and D/E ratio normally we should do a search in the relevant petrochemical industry company but due to the limited time and short of people I plan to use the data available on Exhibit 5, and decided to use arithmetic averages on D/E ratio and β to calculate cost of capital for Petrochemical division. Corporate β = Average (E&P β, R&M β, Petrochemical β) 1.25 = Average(1.15, 1.20, Petrochemical β)Petrochemical β = 1.40 Re = Rf + β(EMRP) Re = 4.98% + 1.40 (5%) = 11.98% Rd = Rf +Petrochemical Spread to Treasury Rd = 4.98% + 1.35% = 6.33% Corporate D/E = Average ( E&P D/E, R&M D/E, Petrochemical D/E)59.3% = Average(39.8%, 20.3%, Petrochemical D/E) Petrochemical D/E = 117.8% By using the formula we can get the answer WACC for Petrochemical is 7.59%.

In the end, as we can see from the report, some of the data is not that accurate because of the small samples and no research in the relevant industry, so for the next case report it is quite important to increase the sample and make sure all data are up to date.

...