726 Words3 Pages

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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