Midland Energy

Calculate Midland’s Weighted Average Cost of Capital (WACC)

Since Midland Energy as a whole, E&P and R&M take on longer-term projects, the 30-year risk-free rate seemed appropriate to use. The 1-year risk-free rate would be applicable for Petrochemicals as they usually take on short-term projects. The cost of debt of 6.60% is calculated using the 30-year rate on U.S. Treasury bonds including the spread to Treasury for the consolidated company.

Using the same risk-free rate of 4.98%, Midland’s beta of 1.25 and the EMRP of 5.00%, the cost of equity is 11.23%.

Over the last three years, an assumed tax rate of 39.73% is calculated. This tax rate is based on an average of taxes paid divided by income before taxes. Midland’s WACC is 8.17% using the ratios of debt and equity given for the consolidated company.

rd = rf + Spread to Treasury

rd = 4.98% + 1.62%

rd = 6.60%

re = 4.98% + (1.25 x 5.00%)

re = 11.23%

rd= 6.60%

re= 11.23%

D/V = 42.2%

E/V = 57.8%

T= 39.73%

WACC = (0.066)(0.422)(1 – 0.3973) + [(0.1123)(0.578)]

WACC = (0.066)(0.422)(0.6073) + [(0.1123)(0.578)]

WACC = 0.01679 + 0.06491

WACC = 0.0817

WACC = 8.17%

Midland uses an EPRM of 5.0%. Based on the historical data given, it seems to be slightly low in comparison to the higher EMRPs that were used in the past (6.0% to 6.5%). Taking the average of the historical data given, the EMRP would average at 6.02% making it closer towards 6.0%. Thus, I would recommend using an EMRP of 6.0%.