Midland Energy Resource Inc. Case Analysis

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Financial Management Assignment Midland Energy Resources Inc. Case Analysis Case Analysis Answer 1: The costs of capital estimates prepared by Mortensen’s are used by Midland Energy Resources Inc. For following purposes • Asset appraisal for capital budgeting and financial accounting • For assessing performance • To consider proposals for mergers and acquisitions • To arrive at decisions regarding stock repurchasing Answer 2: The current interest rate being paid on a new loan is used to find rD Consolidated spread to Treasury = 1.62% rD = 30 year yields to Treasury bonds +Overall consolidated spread to Treasury rD = 4.98% + 1.62% rD = 6.60% Tax rate for the company is calculated on the basis of the data provided in exhibit 1 Average tax rate is to be calculated based on the data for years – 2004, 2005, 2006 Tax rate = Income tax/ Income before taxes For 2004: Tax rate = 7414/ 17910 = 41.39% For 2005: Tax rate = 12830/ 32723 = 39.2% For 2006: Tax Rate = 11747/ 30447 = 38.58% An average tax rate for three years come to be : 39.45% Based on exhibit 6 the historical data shows an Equity Market Risk Premium of nearly 6% whereas as per the surveys conducted by financial analysts and firms Indicate EMRP to range between 2.5% to 4.7%. Since analysts on financial markets have a better understanding of the overall market scenario and are well aware about the performance of various companies therefore their estimate of 5% seems to be more appropriate. Midland Inc. Uses the 5% EMRP. Corporate Equity Beta = 1.25 RE = rf + Equity Beta (EMRP) RE = 4.98% +1.25 (5%) = 11.23% Using the formula: WACC = rE ( E/V)+ rD (D/V) (1-t) rE = 11.23% rD = 6.60% D/E = 59.3% E = 100 units D = 59.3 units V =

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