Midland Energy
Essay by ronia • November 4, 2017 • Case Study • 1,765 Words (8 Pages) • 1,178 Views
CASE 3 REPORT
—Midland Energy Resources
GROUP MEMBER
NAME | ENGLISH NAME | ID |
MAO, Xun | Alison | 1155098036 |
FANG，Chenyang | Cathrine | 1155096647 |
CHEN，Xi | Ronia | 1155100618 |
HUANG，Ailin | Helly | 1155100610 |
CHEN，Weiyi | Esther | 1155096111 |
1 Business Overview
Midland Energy Resources, Inc. , a global energy company, has three divisions, that is exploration& production (E&P), refining& marketing (R&M) and petrochemicals. This corporation estimated its annual cost of capital for the corporation and each division from the early 1980s with specific assumptions and inputs.
On a consolidated basis, this firm is in a good financial situation. Net Income increased rapidly in 2005, although a slight decrease in 2006.
In 2007, Midland planned for its annual financial strategy to focus on four pillars, which are 1) Overseas Growth; 2) Value-creating Investments; 3) Optimal Capital Structure; 4) Stock Repurchases. Because of the focus on Financial and investment events, we need to adjust the historical estimated cost of capital to fit the forthcoming risks.
Department | Exploration& Production | Refining& Marketing | Petrochemicals |
Rev.(2006,$m) | 22,357 | 202,971 | 23,189 |
g% of Rev. | 7.13% | -1.81% | 7.07% |
EAT(2006,$m) | 12,556 | 4,047 | 2,097 |
g% of EAT | -5.94% | -7.64% | -3.01% |
Profit margin | 56.16% | 1.99% | 9.04% |
Position | - Most profitable business - Net income was highest among industry | - Largest revenue business - Small margin consistent with the long-term trend in industry | - Small division - A substantial business |
Revenue drivers | - Rising demand due to continued global population and economic growth - Production from non-traditional recourses is increasing - Shifting geographic composition of output | - Advanced technology and vertical integration combined will make Midland a market leader - Stiffer competition | / |
Cost drivers | - Continued heavy investment in acquisitions - High prices hinder investments in sophisticated extraction methods | - Little investment for difficulty of obtaining the myriad approvals - A long-term global shortage of refining capacity | - Growing expense on replacement for old facilities - Most investment will be JV outside US. |
2 Uses of WACC
2.1 Asset appraisals (for both capital budgeting and financial accounting)
When do asset appraisals, we use WACC to find out whether right price is paid. For Midland, assets include mining equipment, license for exploration, storage tanks, transportation facilities etc.
We also use NPV to evaluate & identify projects that would add value to firm. Projects with highest NPV are usually preferred.
[pic 1]
(if IRR>WACC, accept the project)
2.2 Performance assessments
We use WACC to calculate EVA, in order to illustrate the firm’s financial performance and growth potential of the firm to shareholders.
[pic 2]
2.3 Merger& acquisition proposals
We use WACC in M&A projects in order to evaluate the benefits of acquisition.
[pic 3]
2.2.4 Share repurchase analyses
We also use WACC to decide whether we should conduct share repurchase. When WACC is smaller than earning yield, then the EPS will raise, and we should repurchase the share.
3 Midland’s corporate WACC
3.1 WACC calculation of the corporation
We calculate the current cost of capital and targeted cost of capital based on the WACC model, the formula is
[pic 4]
Firstly, we listed several assumptions about the various inputs to the calculations.
- . We calculate by adding a spread over a similar maturity U.S. Treasury bonds. [pic 5][pic 6]
- . The actual D/V is calculated by the historical financial data and the target D/V is based on the firm’s estimation.[pic 7]
- . We use the average tax rate in the past 3 years as our tax rate.[pic 8]
- . We use CAPM model to calculate the Cost of Equity. [pic 9]
- Use 10-Year U.S. Treasury bonds rate as .[pic 10]
- The actual WACC use Midland’s beta published in commercially available databases, which is 1.25 but the estimated WACC use the beta calculated by the target D/V and unleveraged beta.
- The EMRP used is under the following consideration.
Based on our assumption of each parameters, we can easily calculate the corporate’s actual and targeted WACC.
3.2 Corporation’s Actual WACC in 2006
3.1.1 Cost of Debt
[pic 11]
Based on Table 1 in the case, this corporate estimate it’s consolidated credit rating as A+, so the Spread to Treasury is 1.62%. Table 2 gives us the yields to maturity for U.S. Treasury bonds in different maturity. The debt of the company was mainly long-term debt, so 1-Year is too short to capture the risk and 30-Year is too long due to volatility of this industry. Overall, we choose the 10-Year bonds’ rate 4.66% as the benchmark. So, the is 4.66%+1.62%= 6.28%[pic 12]
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