The WACC Essay For Midland Corp And Divisions.

Calculation of WACCs for Midland Corporation

The above calculation shows that the WACC of Midland Corporation is estimated at 10.95%. further, it has been perceived that the risk free return is estimated at 4.66 percent and the cost of equity is 10.91%. Further, it has been found that the cost of debt of the company is higher than the cost of equity standing at 13.94%. the higher amount of cost of equity shows that the company shareholders are at a risk state and therefore the firm might not get future potential investors (Shen and Zhang 2020). Further, it can be noted from the above analysis that the company is riskier to invest since its cost of debt is higher than cost of equity.

If the corporation utilized a single capital requirements or hurdle level, all units would be assumed to be identical. The use of a single hurdle rate ignores the differences in debt levels and asset types within divisions. Midland's E&P sector, for instance, has oil deposits as well as a larger requirement for development capital spending. In addition, the desired debt ratio varies each division. The company’s risks can also be differentiated for divisions operating in various industries. R&M, for instance, runs on tighter margins, putting it at more risk. However, if the firm consider that it has been operating for a long period, the likelihood of lowers. In addition, because to its market maturity, this division does not require a large amount of money. In light of the foregoing, it is preferable to employ distinct hurdle rates for every segment since this will offer the organization with more precise and complete information about the predicted riskiness.

To estimate the cost of equity of the company, the average number of equity beta is used which is 1.15. Further, it has been found that the risk premium is also utilized and the cost of equity and debt has been used for evaluating Weighted average cost of capital for each of the divisions. Further, it has been also found that the DE ratio of 39.80 percent and 20.30% has been used in this calculation. The equity beta for both the exploration and production division has been estimated at 1.15 and 1.20 respectively. In this section, it has been found that the WACC for exploration section has been slightly lower than the other section (Johnson, Liu and Yu 2021).  Given the capital structure for both of the divisions, the average historical data for the market risk premium should always be close to 6 percent and further it has been also found that the given the current situation of the company, the investors can demand higher return to compensate for higher risks present within the company.  

References

Johnson, T.C., Liu, P. and Yu, Y., 2021. The Private and Social Cost of Equity-Maximizing Debt Policy.

Shen, C.H.H. and Zhang, H., 2020. What's good for you is good for me: The effect of CEO inside debt on the cost of equity. Journal of Corporate Finance, 64, p.101699.