Midland Case

Midland Energy/Sample 2

Midland Energy Resources, Inc.

Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and

production (E&P), refining and marketing (R&M), and petrochemicals. Midland’s most profitable

segment is its E&P division which produces 67% of the company’s net income (Exhibit 3). Its largest

division is R&M with the Petrochemical division being the smallest. The primary goals of Midland’s

financial strategy are to fund substantial overseas growth, invest in value-creating projects, achieve an

optimal capital structure, and repurchase undervalued shares.

To accomplish these goals, Midland must calculate an appropriate cost of capital that will allow

reasonable valuations of their strategies. In funding overseas growth, Midland must use its cost of

capital to analyze, evaluate, and convert foreign cash flows. In evaluating value-adding projects, the cost

of capital must be used to discount project cash flows. To optimize its capital structure, the company

must continuously evaluate its ideal borrowing based on its inherent cost. Lastly, when deciding when

and how to repurchase shares, Midland’s management has to determine the intrinsic value of its shares.

This requires determining the value of the company using DCF techniques and an appropriate discount

rate.

Cost of Capital

Estimates of Midland’s cost of capital are used in analyses within the company and its three divisions.

These analyses include asset appraisals in capital and financial accounting, performance assessments

often used to determine compensation, merger and acquisition proposals, and stock repurchase

decisions. These anticipated uses of Midland’s cost of capital should not affect the calculations if the

projects being evaluated are of the same average risk of all company projects. If the projects are of

greater or less risk, the calculations of WACC may be affected. As an example, for a riskier M&A

proposal, the...