Midland Energy Resources

Introduction

Janet Mortensen, the Senior Vice President of Project Finance for Midland Energy Resources has been estimating the company’s cost of capital since 2002 in connection with a large proposed share repurchase. Ms. Mortensen has continued similar informal analysis exercises for all Midland related companies on an annual basis. The exercises conducted by Ms. Mortensen benefited the entire Midland organization as well as the separate divisions. The calculations for the cost of capital are often challenging but provide great insight for an organization and its investors as it gives an idea of the minimum required return for investors based on the capital they have provided a company. These calculations, though not required, are still important for Midland Energy Resources and its related companies because after the cost of debt and the cost of equity have been calculated, the companies are able to complete a weighted- average cost of capital (WACC) calculation for projections. In order for Midland to appear to be a good investment for investors, they must provide a greater return on capital versus the initial cost of capital. This case presentation provides analysis on the cost of capital for the related Midland companies.

Use of Information. The calculations from the analysis conducted by Ms. Mortensen are used to determine the cost of capital on a corporate level as well as a divisional/business unit level for review and future projections. The estimates are eventually used by Midland and related companies for asset appraisals related to capital budgeting and financial accounting, performance assessments, M&A proposals and decisions related to potential stock repurchases. The calculations are also important because they are an essential component for weighted-average cost of capital.

The anticipated uses of the estimates for Midland’s cost of capital should not affect the calculations if there are no differences in the risk for the...