Midland Energy Resources

In: Business and Management

Submitted By cavalencia
Words 3942
Pages 16
4129
JUNE 19, 2009

TIMOTHY A. LUEHRMAN JOEL L. HEILPRIN

Midland Energy Resources, Inc.: Cost of Capital
In late January 2007, Janet Mortensen, senior vice president of project finance for Midland Energy Resources, was preparing her annual cost of capital estimates for Midland and each of its three divisions. Midland was a global energy company with operations in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. On a consolidated basis, the firm had 2006 operating revenue and operating income of $248.5 billion and $42.2 billion, respectively. Estimates of the cost of capital were used in many analyses within Midland, including asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. Some of these analyses were performed at the division or business unit level, while others were executed at the corporate level. Midland’s corporate treasury staff had begun preparing annual cost of capital estimates for the corporation and each division in the early 1980s. The estimates produced by treasury were often criticized, and Midland’s division presidents and controllers sometimes challenged specific assumptions and inputs. In 2002, Mortensen, then a senior analyst reporting to the CFO, was asked to estimate Midland’s cost of capital in connection with a large proposed share repurchase. Six months later she was asked to calculate corporate and divisional costs of capital that the executive and compensation committees of the board could incorporate in planned performance evaluations. Since then, Mortensen had undertaken a similar exercise each year and her estimates had become widely circulated de facto standards in many analyses throughout the company, even ones in which they were not formally required. By 2007 Mortensen was aware that her…...

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...Copyright © 2009 Harvard Business Publishing. To order copies or request permission to reproduce materials, call 1-800-545-7685 or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business Publishing. Harvard Business Publishing is an affiliate of Harvard Business School. T IMOTHY A. LUEHRMAN JOEL L . HEILPRIN Midland Energy Resources, Inc.: Cost of Capital In late January 2007, Janet Mortensen, senior vice president of project finance for Midland Energy Resources, was preparing her annual cost of capital estimates for Midland and each of its three divisions. Midland was a global energy company with operations in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. On a consolidated basis, the firm had 2006 operating revenue and operating income of $248.5 billion and $42.2 billion, respectively. Estimates of the cost of capital were used in many analyses within Midland, including asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase decisions. Some of these analyses were performed at the division or business unit level, while others were executed at the corporate level. Midland’s corporate treasury staff had begun preparing annual cost of capital estimates for the corporation and each division in the early 1980s. The......

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...Message Our team has performed thorough analysis surrounding the questions of cost of capital for Midland Energy Resources, Inc. (Midland). Here are the results of our research: 1. Ms. Mortensen estimates Midland’s cost of capital for a variety of reasons including use for capital budgeting, financial accounting, performance assessments, stock repurchase estimations, and potential “M&A” opportunities. In addition, Midland relies on the cost of capital to deliver on the financial and investment policies set forth by the Board. Finally, the cost of capital is also used in relation to expected growth and forecasted demand. To explain, if the forecasting department foresees an increase in sales of resources, Ms. Mortensen can use the cost of capital to properly determine if it is financially sound to make an investment in the company to support that demand. Should Ms. Mortensen overestimate the cost of capital for the firm, Midland may miss out on investment opportunities and will under value the investment at hand. Furthermore, it is possible for shareholders to see a lower return on their investment. At the other end, in which the cost of capital is understated, Midland may engage in an investment that is potentially “bad” and will be overvalued. Shareholders will see over inflated returns based on this approach. 2. Based on our calculations, our team has determined that Midland’s firm-wide WACC is 8.48%. Assumptions that our team made can be found......

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