You are the analyst Mortensen. Issues:
1. Which WACC to use for determining the Cost of Capital - company as a whole or each division? What is the purpose of calculating the WACC? Should it be used for determining a) target price for shares, b) management incentives, or c) which projects or expenditures should be taken by the company or division?
WACC = [D/EV * kd(1-t)] + [E/EV * ke]
a. What is the value of the Debt and Equity on their balance sheet for capital structure (exhibits 1 & 2)?
b. What is the Enterprise Value (EV) of Midland?
c. What is Midland's Kd (Cost of Debt)?
d. Is Midland's D/EV constant over time? Should you use the current D/EV or their "target" debt ratio?
e. What is Midland's tax rate?
f. What is Midland's Ke (Cost of Equity)?
Using CAPM: Ke = Rf + β(Rm - Rf)
a. What is Midland's Equity Beta (βe)?
b. What is the Risk Free rate? (Different rates for different timeframes ["Yield curve"])
c. What is the Market Return for equity (EMRP)? At time of the case (2007)? (Different EMRP for different securities & different markets)
2. What is Midland's UNLEVERED Beta (the risk of the company if they had NO DEBT)?
Beta (risk) changes with leverage. You must recalculate the beta for the company after every change in the DIE ratio with the process of "relevering beta."
EV* βunlevered = [E * βe] + [D * βd]
What is the Beta of Debt?
βunlevered = βlevered [1+D(1-t)/E
Attachment:- Assignment.rar