1. I low are Mortensen's estimates of Midland's cost of capital used? IIow, if at all, should these anticipated uses affect the calculations? 2. Calculate Midland's corporate WACC. Be prepared to...

Answer 1
Initially in 2002, Mortensen prepared a cost of capital in connection with a stock repurchase.
Some months later, he prepared corporate and divisional costs of capital for planned
performance evaluations. Prior to Mortensen , these costs of capital was prepared by the
Treasury division but was highly challenged due to its assumptions and inputs Mortensen,
cost of capital started gaining popularity and today Mortensen costs of capital are widely used
in most of the financial analysis taken by the company.
Mortensen costs of capital were used by the company in the following ways:
1) For value creating investments – Midland uses discounted cash flow analysis to
evaluate prospective investments. Mortensen used to calculate the weighted average
cost of capital for discounted cash flow analysis the project or division. However,
Midland sometime used cost of equity evaluated by Mortensen for its overseas
investments
2) Stock repurchases – Midland used Mortensen’s cost of capital to calculate the
fundamental value of the company based on the discounted cash flow analysis. The
market value of the debt is reduced from the fundamental value of the company and
divided by the no of shares, to give the intrinsic value of the shares.
3) Capital budgeting – To ensure that the company has optimal capital structure, the
company used the weighted average cost of capital to evaluate the level of debt in the
company/ division.
When Midland calculates its cost of capital for various divisions, special
consideration needs to be given to the fact that various divisions are not publicly
traded companies. If the weighted average cost of capital is evaluated against as listed
company it is okey, otherwise not. Mortensen uses beta averages of various
companies having similar businesses as various divisions of Midland and then
evaluate cost of capital of various divisions.
Answer 2
To calculate the cost of equity, the following formula needs to be applied;
 Weighted average cost of equity =
Re(Equity/ (Debt+equity) *100 + Rd(Debt/Equity+debt)(1-tax rate)
Re = return on equity
 Rd = Rate of interest on debt
(To calculate the interest on debt – I am assuming the interest paid on current debt levels
will...