During 2006, the segment had $22. Ban of revenues and after-tax earnings of $12. Ban. Capital spending in Exploration and Production was expected to exceed $ban in 2007 and 2008. Measured by Revenue, Midland’s refining and marketing business was the Company’s largest. Global revenues for 2006 were $Bonn and after-tax earnings were only $Ban. Petrochemicals were the smallest division in terms of revenue. In 2006, revenue and after-tax earnings from this division were $23. Ban and $2. Ban respectively. Its Capital expenditure was expected to grow.
The 2007 Financial Strategy for Midland was based on 4 strategies: ) Overseas Growth: The investment that Midland made abroad was converted into US dollar from foreign currencies and after applying US dollar discount rate. 2) Value-creating Investments: Midland used discount cash flow methodologies to evaluate most prospective investments. So, Midland rely on NIP technique for evaluating investment 3) Optimal Capital structure: Midland optimized its Capital structure in large part by prudently exploiting the borrowing capacity inherent in its energy reserve.
So, the company maintained an optimum capital structure to shield its additional profit from axes (as debt provides benefit of trading on equity). Each of Midland’s divisions had its own target debt to equity ratio. 4) Stock Repurchase: The Company regularly estimate the intrinsic value of its shares by subtracting the market value of its debt from the fundamental value of the enterprise and dividing the result by the number of shares outstanding. When the stock price fell below the stocks intrinsic value, Midland considered repurchasing it.
So, calculation of cost of capital for each division and corporate is very important and crucial for the company. Hence, Moroseness should take extra care in estimating its cost of capital for each division and corporate for calculation of cost of capital for 2007. Moroseness’s primary calculations were based on the turmoil tort WAC shown below: WAC = rd (I-t) D,V+ re EN Where D = Debt; E = Equity; rd = cost of debt; re = cost of equity; V(Value) tax rates CALCULATIONS: 0? Calculation of Cost of Debt for each division and corporate: Moroseness compute each division by adding a premium or spread over US Treasury.
Exploration and Production’s cost of debt (rd) 4. 98 + I . 66 6. 8 Refining and Marketing’s cost of debt (rd) 4. 98 + I . 80 6. 78 Corporate Level cost of debt (rd) 4. 98 + I . 62 6. 6 NOTE: All the US treasury bonds are assumed to be of 30 years 0? Calculation of cost of equity for each division and corporate 0? Company use capital asset pricing model for calculation of cost of equity CAMP ? RFC+ (EMMER) RFC = risk free rate of return = beta (systematic risk) EMMER = market risk premium 0?
CALCULATION OF BETA: TA published in commercially available databases were us deed rather than running their own regressions to calculate Beta ) For estimating betas for division, Moroseness relied on published beta for publicly traded companies which she deemed comparable to each division’s business 0? Risk Free Rate Of Return: 4. 98% 0? Equity Market Risk premium (EMMER): 0? In 2006, Midland used 5% as EMMER, but historical data support a higher estimate of EMMER and other survey results suggest a lower figure (2. 5-4. 7%)