20317Midland.pdf - Midland Energy Cost of Capital Estimates...

Midland Energy
Cost of Capital Estimates for 2007
Finance 203: Midland Energy 1

Midland
• A global energy company
– 2006 Operating Revenues of $248.5 billion
– 2006 Operating Income of $42.2 billion
– 2006 After tax earnings $18.7 billion
– $240.1 billion of non-cash assets
– $22.3 billion cash
– Three Divisions
• Oil and gas exploration and production (E&P)
• Refining and Marketing (R&M)
• Petrochemicals
Finance 203: Midland Energy 2

Midland’s Divisions
• Oil and gas exploration and production (E&P)
– 2006 Operating Revenues of $22.4 billion
• 9% of Midland 2006 Operating Revenues
– 2006 after tax earnings of $12.6 billion
• 67% of Midland 2006 after tax earnings
– $140.1 billion of assets
• 53% of Midland 2006 assets
Finance 203: Midland Energy 3

Midland’s Divisions
• Refining and Marketing (R&M)
– 2006 Operating Revenues of $203 billion
• 82% of Midland 2006 Operating Revenues
– 2006 after tax earnings of $4 billion
• 21% of Midland 2006 after tax earnings
– $93.8 billion of assets
• 36% of Midland 2006 assets
Finance 203: Midland Energy 4

Midland’s Divisions
• Petrochemicals
– 2006 Operating Revenues of $23.2 billion
• 9% of Midland 2006 Operating Revenues
– 2006 after tax earnings of $2.1 billion
• 11% of Midland 2006 after tax earnings
– $28.5 billion of assets
• 11% of Midland 2006 assets
Finance 203: Midland Energy 5

Midland’s Cost of Capital Estimates
• First calculated in 2002
– For Midland
• For use in stock repurchase decision
– For each of the divisions
• For performance evaluation
• For capital budgeting decisions
Finance 203: Midland Energy 6

Equity Return for Midland
• Use for deciding whether to repurchase shares
– Discount flows to equity
– Gives Equity Value as PV of equity flows that can be
compared to the market cap (share price*shares)
Finance 203: Midland Energy 7
 
6 Exhibit from is EMRP
2 Table from Bond - T year - 30 is
5 Exhibit from is
Return Equity
f M
f
E
f M E f E
E
r Er
r
r Er r Er
Er
 
  




Expected Market Return Premium
(EMRP)
• Exhibit 6 Table A: Historical averages range from 5.1% to 7.1%
• Exhibit 6 Table A: Survey results give lower numbers ranging from
2% to 4.7%
• We’ll use:
– 3.6% (Welch Median) (serves as Lower Bound)
– 5%* Midland choice near 4.8% (1967-2006 average) recent, relatively
high standard error but close to 1798-2006 average of 5.1% which has
the lowest standard error
– 6% past Midland choice
– 7.1% (1926-2006 average) relatively low standard error, highest
historical average (serves as Upper Bound)
• We’ll focus on 5%
• Others will be used for sensitivity analysis
Finance 203: Midland Energy 8

Midland Equity Return
Finance 203: Midland Energy 9
Midland Equity beta (Exhibit 5) 1.25
30 treas rate (Table 2) 4.98%
Midland
EMRP
Equity
return
3.60% 9.48%
5.00% 11.23%
6.00% 12.48%
7.10% 13.86%

WACC for Midland
• Use for deciding whether to repurchase shares
– Use to discount UFCF
– PV of UFCF, discounted at WACC, gives Enterprise
Value (EV) of Midland
– Equity Value of Midland equals Enterprise Value less
net debt
• Equity value can be compared to Midland’s market cap for
the purpose of deciding whether to repurchase shares
Finance 203: Midland Energy 10