Corporate Financial Management 2014
Graded case 2: Midland Energy Resources, Inc.
Read the case material (case 4129) regarding the Midland Energy company. We see that Midland is a
company that has diversified into several (related) industries, which means not all divisions are likely
to be equally risky. Moreover, the proper discount rate will be influenced by a lot of other factors,
including taxes and leverage. As always, part of the problem is to determine which data sould be
used.
Prepare a report (this will be handed in through Blackboard, the same procedure as for the first case
will be used) that answers the following questions. Show your calculations in the report!
A. Determine Midland’s corporate (enterprise-wide) WACC. Mention your main assumptions –
especially regarding the corporate tax rate used and the leverage ratio, but also regarding other
inputs – and explain why you think these numbers are the best in this situation.
B. Also conduct a sensitivity analysis on your answer in question A: what are the effects if the
corporate tax rate increases or decreases by 5 points (so, for example, from 22 to 17%; do not use
these numbers, investigate both an increase and a decrease) and if the company would recapitalize
to a debt/value ratio of 75% (using share repurchases).
C. Argue why a single corporate discount rate should or shouldn’t be used by Midland. Explain the
consequences of making the wrong choice (between a single or different discount rates). Include in
your answers what will happen with divisions/companies that use a discount rate that is too low, and
compare with divisions/companies that use a discount rate that is too high, and what kind of
consequences this will have for the managers and their performance.
D. Compute a separate cost of capital for the E&P and marketing and refining divisions.Again,
mention and defend your assumptions, now place special emphasis on which betas and returns you
use.
E. Midland is active in different countries. Argue if the risk related to countries (e.g. political turmoil)
should be included in the WACC, and if so, how.
