π Midland Energy Resources
Core Lesson: Divisional WACC, cost of capital
π Overview
| Attribute | Detail |
|---|---|
| Subject | Finance |
| Core Lesson | Divisional WACC, cost of capital |
| Source | HBS / Top MBA Case |
π°οΈ Background
Midland Energy Resources is a diversified energy company operating in three segments: oil exploration & production (E&P), refining & marketing (R&M), and petrochemicals. CEO Janet Mortensen must calculate a separate cost of capital (WACC) for each division to evaluate capital allocation decisions and project-level investments.
β The Central Problem
Nearly identical to the Marriott case in structure: a multi-division company must decide whether to use a single company-wide WACC or divisional WACCs. The three divisions have very different risk profiles β E&P is high-beta (commodity price volatility), R&M is moderate (margin-driven), and petrochemicals is lower-beta (contracts, less volatile). Using one WACC misallocates capital.
π Analysis
Students must: (1) Identify comparable pure-play companies for each division, (2) Unlever comparable betas to get asset betas, (3) Re-lever at Midlandβs target capital structure for each division, (4) Calculate divisional cost of equity via CAPM, (5) Estimate divisional cost of debt, (6) Compute three separate WACCs. Key debate: choice of risk-free rate (short vs. long government bond) and equity risk premium.
π Key Lessons
- Divisional WACCs are essential for multi-business companies β otherwise capital flows to highest-risk divisions
- The choice of risk-free rate (T-bill vs. T-bond) significantly impacts cost of equity calculations
- Pure-play comparables are imperfect β judgment is required in selecting and weighting proxy companies
- Tax rate and target capital structure assumptions can materially change the WACC
π Discussion Questions
- How would you select pure-play comparables for each of Midlandβs three divisions?
- Should Midland use 1-year or 10-year or 30-year Treasury as the risk-free rate? Why?
- What happens if Midland uses a single WACC β which division benefits and which is penalized?
οΏ½οΏ½ Connected Concepts
WACC, CAPM, Capital Structure, Comparable Company Analysis, DCF Valuation