Midland Energy Resources Cost Of Capital Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Midland Energy Resources Cost Of Capital Case Solution

INTRODUCTION

Midland energy resource is one of the global companies in the profitable sector of oil and gas. It is not only engaged in the field of exploration and production (E&P) but is also performing operations in refining and marketing (R&F) and petrochemicals. Midland considers exploration and production sector as the largest productive industry for its revenue, which contributes more than 65% of the total revenue of the company.

Midland's management decided to take positive steps towards overseas growth by making investments in valued projects, which further led the company to achieve optimal capital structure. This is because optimal capital structure not only saved the company from bankruptcy and agency cost, but also contributed to handling the matter of tax exhaustion.

However, capital structure decision is difficult for a small-scale firm because of small initial investment, but a company like Midland has a lot of opportunities while making capital structure decision. Midland’s management is focused on achieving the appropriate cost of capital as it is one of the greatest challenges to determine how much debt and equity should be used in financing to achieve optimal capital structure. For all these goals, an excellent financial analysis is considered necessary, especially for the evaluation of the cost of capital.In addition to this, it would help the company to evaluate the value of its different projects by using the method of discounting project cash flows.

PROBLEM STATEMENT

Midland wants to identify its optimal capital structure by determining its intrinsic value regarding shares. In addition to this, Midland also wants to analyze the ideal borrowing with respect to its cost.

ANALYSIS

FINANCIAL ANALYSIS

Calculating WACC

The financial analysis of Midland examines its cost of capital as it would help to determine the optimal capital structure of the company with the aid of the perfect mixture of debt and equity financing.

Midland‘s cost of capital consists of its operations in its three divisions such as oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. It requires asset appraisals which take place in the capital, mergers, and acquisition proposed by Midland and the decision regarding stock repurchase. These measures are also affected by different levels of risk such as higher or lower than the average risk faced by the company’s projects. (WACC the dog: The effect of financing costs on the Levelized cost of solar PV power, March 2015)

The weighted average cost of capital focuses on the company’s cost of capital on the weight allocated to each category. WACC is one of the opportunity costs for the company to invest its money. It includes all sources of capital such as common stock, preferred stock, bonds and long-term debts (maturity having more than one year such as treasury and corporate bond, government bonds, etc.). It helps the company to make its decision appropriately towards the selection of capital. (Lee)

WACC Midland = (1-t) rd (D/V) + re (E/V) ---------- --eq (1)

Where,

rd is the cost of debt

re is cost of equity

D/V is the proportion of debt with total value of company

E/V is the proportion of equity with total value of company

t is the tax rate

Steps for WACC calculation:

Step 1: tax rate:

The cost of debt capital is equal to the interest rate on the company's debt, which is adjusted for the tax deduction of interest expenses. It implies tax payments correspond with interest payment as the company is subject to tax withheld from its customer to pay taxes soon. It would be beneficial for the company to do tax saving in the same year as taxes and interest expenses are paid since EBIT (earnings before interest and taxes) is equal or greater than the amount of interest paid. For the calculation of WACC, it has assumed tax rate as 40%..................

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Midland Energy Resources Cost Of Capital Harvard Case Solution & Analysis