Case No.

5 Midland Energy
Due Date 04/27/2016, 9.30am via Email

Learning Objectives and Assumptions

By now you are familiar with the basic valuation techniques for firms and projects. A key component to
the correct application of any discounted cash flow model is the relevant cost of capital. In this case we
will extend our existing framework for estimating the cost of capital for a firm to individual divisions and
projects within the firm. Specifically, this case asks you to make the correct adjustments to the weighted
average cost of capital when division or project risks are different from the average risk of the company.
Most of the information you require for this case should be contained in the case, or in the exhibits. If you
feel that a required piece of information is not given in the case you are allowed to make your own
assumptions and/or to use publicly available data.
Your write-up should be as concise as possible and you must explain your answers. In terms of format,
number of pages, etc. the usual standards apply.
This is an individual assignment and will be graded. Failure to hand in the case report on time will result
in a 20% reduction of your score per day your case report is delayed. You are certainly allowed and
encouraged to meet in groups outside of class in order to discuss and analyze the cases. However, your
write-ups have to be your own individual work. Plagiarism is a serious offense and will result in a failing
grade for this course as well as additional disciplinary sanctions.

Question 1 (10 Points)

a. Why does Mortensen attempt to estimate separate WACCs for each of Midlands divisions?
Shouldnt the relevant cost of capital be based on the cost for the entire firm (i.e. the combined
divisions)?
b. Suppose Midland executives were to only use the company wide WACC for capital budgeting
purposes. How would this likely affect the companys performance?
Question 2 (10 Points)
Estimate the WACC for 2007 for Midland on a consolidated basis (i.e. for the entire firm). Be careful to
describe and justify your assumptions as well as any adjustments that you have made.
Questions 3 (15 Points)
Estimate a separate WACC for the E&P division as well as for the Marketing & Refining division for 2007.
Be careful to describe and justify your assumptions as well as any adjustments that you have made. Please
include a table outlining your calculations in your write-up.

Question 4 (10 Points)

Suppose you are trying to value a project for the Petrochemical division of Midland. The project will
require an initial investment outlay of $10mn and will generate free cash flows of $0.8mn in perpetuity.
Would you advise taking or rejecting this project? Explain your reasoning.
Question 5 (15 Points)
Suppose that the division head for Refining & Marketing has repeatedly criticized the divisional WACC
approach that Mortensen is advocating. She claims that Refining & Marketing is being punished using
the divisional WACC approach because the board of directors forces her to use considerably less leverage
than the other divisions are allowed to use. She argues that, because debt financing is generally cheaper
than equity and brings additional tax benefits, the WACC for Refining & Marketing would be similar to the
one of E&P if Refining & Marketing were allowed to use the same amount of leverage as E&P.
Is the division head for Refining & Marketing correct? Explain your answer using numerical data where
appropriate.