Midland Energy Resources Inc. 1.

Midlands consolidated WACC WACC = (Debt/Capital)kd(1-t) + (Equity/Capital)ke Debt and Equity are measured at their market values. Capital = Debt + Equity 1.1. Capital structure ratios Actual (Debt/Capital)actual = 37,2% (Debt/Equity)actual = 59,3% (Equity/Capital)actual = 62,8% Target (Debt/Capital)target = 42,2% (Debt/Equity)l = 73,0% (Equity/Capital)target = 57,8% 1.2. Cost of debt kd = US 30-Year T-Bond yield + spread = 4,98% + 1,62% = 6,60% 1.3. Tax rate Tax rate = 40% 1.4. Cost of Equity ke = risk-free rate + (EMRP) risk-free rate = 30-year T-bond yield = 4,98% EMRP = 5,00% Equity Beta Actual capital structure levered = 1,25 Equity Beta Target capital structure Adjust Midlands beta to reflect the target capital structure: a. un-lever the current beta asset beta = unlevered = levered/[1+(1-t)(D/E)actual] b. re-lever the asset beta to reflect the target capital structure levered = unlevered [1+(1-t)(D/E)target] = 1,33 ke = risk-free rate + (EMRP) = 4,98% + 1,335,00% = 11,61% WACC = 0,4226,60%(1-0,40) + 0,57811,61% = 8,38% 2. Midlands Divisional WACC a. Estimate an asset beta for each division based on data for comparable companies (Exhibit 5) un-lever the equity beta of each comparable company using data on each companys capital structure; average the resulting asset betas estimate the systematic risk of each of Midlands business divisions; compute the asset beta of the petrochemical division considering that Midlands asset beta must be a weighted average of the divisional asset betas (after-tax earnings can be used as weights).

b. Calculate the WACC for each of Midlands divisions according to the procedure described for Midland as a whole in paragraph 1. 3. Leverage and WACC Take one of Midlands divisions and compute its WACC using varying degrees of leverage. Compare the effect of the change in leverage on the cost of equity and on the WACC.