H.J. HEINZ: ESTIMATING COST OF
CAPITAL IN UNCERTAIN TIMES
San Ramon Section I (Early Class)
In this case study, we estimate the weighted average cost of capital (WACC) for H. J. Heinz Company by analyzing its financial conditions as well as macroeconomic variables post 2007-2009 recession years. H. J. Heinz also known, as Heinz in the consumer market, is a US based food giant with billions of dollars in yearly revenue. It is a major player in the ketchup and sauces, infant and nutrition, and meals and snacks market. The three primary competitors for Heinz Company are Kraft Foods, Campbell Soup Company, and Del Monte Food Products. All are similar in terms of financial analysis. As a financial analyst for Heinz, Solomon Shepherd’s main concern is to identify the appropriate WACC, which can be used as a discount rate to accept or reject Heinz Company’s future projects. Given the current financial environment post recession, formulating an appropriate WACC requires some reasonable estimation and what-if analysis based on several variable inputs. This report first breaks down the WACC calculation and then performs the sensitivity analysis of the WACC versus market risk premium and other relevant factors.
I. Capital Structure
For a firm, capital structure defines the distribution of firm’s assets between debt and equity. Since determining capital structure is the building block for WACC calculation, we define the capital structure first. Table 1 shows the debt components for Heinz that has a short and long term debt component as stated in the financial statements in Exhibit-II of the case. During 2010, Heinz had about 317.69 million shares outstanding at a market price of $46.87. The total equity component = stock price * outstanding shares as shown in Table 2. Total Debt component is as shown in Table 1. Debt/Asset ratio is calculated as Total Debt (Market) / Total Asset (Market) and Equity/Asset ratio is calculated as Total Equity (Market) / Total Asset (Market). Debt
Based on the capital structure shown in Table 2, the debt/asset ratio is 0.24 and equity/asset ratio is 0.76. This information will be later used as the appropriate weights of debt and equity to total assets in calculating WACC. II. Cost of Equity
In this section, we calculate the expected return on equity by the shareholders. The cost of equity will be later used to calculate the WACC for Heinz Company. In order to calculate cost of equity, we need Beta for Heinz stocks, risk free rate, and market risk premium. We use the 10 year US government bond rate as an estimate of the risk free rate. Based on the data provided in Exhibit 3 of the Heinz case study, the risk free rate estimate is 3.69%. a) Beta – measures the responsiveness of a security to
movements in the market portfolio. Although beta
for Heinz is based on past data and is provided as
0.62 in the Heinz case, we estimate beta based on
the historical market...
Please join StudyMode to read the full document