AFM373 Lecture Notes - Lecture 7: Asset Turnover, Nopat, Capital Structure
3 Jul 2018
School
Department
Course
Professor
Midland case
Midland WACC
Business risks comes from operations (left side of the balance sheet)
Financial risks = choices of how I finance, D/E, capital structure (right side of the balance sheet)
Midland centrally raising debt and equity and re-financing its divisions.
Each division needs an appropriate allocation of capital and use WACC to determined NPV of
projects. That’s why you need separate WACC for each division to determine which projects are
profitable. WACC determines how much funding the division will get.
For exhibit 3, we can calculate some margins ratio, asset turnover ratio to compare the different
divisions.
You can see that E&P has a high margin and R&M has a low margin (R&M has massive sales but
tiny margin)
oMassive competition in R&M, so lower prices to compete.
oR&M is getting their raw materials (oil) from E&P (digging for oil)
oE&P's high margin is due to low cost of digging oil from the ground and selling it at the
oil price while R&M's low margin is due to high cost of buying the actual oil from E&P
Asset turnover (sales/asset) is low because they have a higher asset because they need to find
land and extract oil. In R&M, asset turnover is high because of their lower asset (just maintaining
what they have to do the job)
E&P is better at securing a loan because they have higher cash flow and more assets used for
collateral.
Role and issue
Why is Janet estimating WACC?
What will the estimates be used for?
WACC will be used to determine projects to take in each division and
Whether or not to purchase stocks with the whole firm WACC
Performance evaluation of individual projects and learn if the WACC is
Accurate
Performance evaluation of the managers that's estimating the WACC
Logic for EVA is if NOPAT - rWACC x investment positive, then it could be a good investment
EVA is not a good measure, they are seeing if you are to make positive on return on capital that
you are giving.
Measured over a particular period, but cannot look forward.
Corporate wide WACC
Investors and the market set the WACC.
What's effecting the cost of capital of all firms together - interest rates (rf on treasury bonds)
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Business risks comes from operations (left side of the balance sheet) Financial risks = choices of how i finance, d/e, capital structure (right side of the balance sheet) Midland centrally raising debt and equity and re-financing its divisions. Each division needs an appropriate allocation of capital and use wacc to determined npv of projects. That"s why you need separate wacc for each division to determine which projects are profitable. Wacc determines how much funding the division will get. For exhibit 3, we can calculate some margins ratio, asset turnover ratio to compare the different divisions. You can see that e&p has a high margin and r&m has a low margin (r&m has massive sales but tiny margin: massive competition in r&m, so lower prices to compete. o o. R&m is getting their raw materials (oil) from e&p (digging for oil)
