Midland energy resources case of cost of capital harvard business
Related Papers. Midland is too large of a corporation, with different divisions, each containing its own unique set of risks. Midland owned twenty-five manufacturing facilities and five research centers in eight countries around the world.
Midland energy resources executive summary
Divisional Cost of Capital The use of a single corporate hurdle rate for evaluating investment opportunities in all its divisions would assume that the risk and return for each investment would be the same across all divisions. Midland operates 3 divisions with very different debt structures and assets within each division. If the projects are of greater or lesser risk, then the calculations of WACC may be affected. Lastly, Midland should not use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions because each division is different. With oil prices at historic highs in early , Midland anticipated heavy investment in acquisitions of promising properties, in development of its proved undeveloped reserves, and in expanding production. The cost of debt is calculated as the 10 year rate on U. To meet these goals, Midland must calculate an appropriate cost of capital. This produces an equity divisional beta of 1.
Weights have been assigned to each division on the basis of total assets for the year as seen in Exhibit D. The 1year rate does not capture the assets financing the borrowing and the 30 year rate is not appropriate given the changes that are possible in the industry in that timeframe that Midland cannot adequately capture and model in its business.
That is the longest sample size in regards to time, as well as having the lowest standard of error.
In evaluating the performance of a business or division based on the economic value added model, the capital charge is computed as the cost of capital for the business or division times the amount of capital it employed during the period.
We can calculate this using beta for publicly traded companied outlined in the case. Capital spending in petrochemicals was expected to grow in the near term.
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