Midland

To calculate Midland’s Corporate WACC, we use the equation:

WACC = rd (D/V) (1-t) + re (E/V)

First, to calculate rd we take the current consolidated spread to treasury, which is 1.62% and add it to the current 30 year maturity, which is 4.98%, giving us a rd of 6.60%.

rd = 4.98% + 1.62% = 6.60%

To find the tax rate we used Exhibit 1, we used an average from the years provided which were 2004-2006, we took the total taxes paid for the three years and divided by the total income before taxes for the three years.

| 2004 | 2005 | 2006 | Total |

Income before taxes | 17,1910 | 32,723 | 30,447 | 81,080 |

Taxes | 7,414 | 12,830 | 11,747 | 31,991 |

| | | | |

t= $31,991/$81,080 = 39.46%

Next, we must calculate the cost of equity or the re, Mortensen used Capital Asset Pricing Model (CAPM) in which rf denotes the risk- free rate of return, beta is a measure of systematic risk, and EMRP is the equity market risk premium or the return on a broadly diversified portfolio of risky assets is expected to exceed the risk-free return over a specific period.

re = rf + beta ( EMRP)

Midland management used an equity market risk premium of 5.0%, the beta used is 1.25, which is found published in commercially available databases, and an rf of 4.98%, which is provided in Table 2 and is the 30 year maturity Treasury bond rate.

re = 4.98% + 5.0% (1.25) = 11.23%

In table 1 we are given the consolidated debt/value of 42.2%, we will use that for D/V. The firm’s E/V was calculated simply by taking 1 – the D/V, giving us 1 - .422 and equaling .578. Now we have all the pieces to calculate the WACC for Midland:

WACC = .066* (.422) (.605) + .112 (.578) = .0816 = 8.16%

In looking at the equity market risk premium used by Midland of 5%, we believe this is an appropriate EMRP to use based on market data provided. We did note that historical data suggests that a slightly higher EMRP around 6 to 6.5% could have also been used and been appropriate as well. We believe...