H.J Heinz-Weighted Average cost of capital Case Solution
Using the above formula, the cost of equity is calculated to be 8.44%.
Cost of Debt
The cost of debt has been estimated using the bond information (given in exhibit 3). The average of bond rates was taken as the cost of debt, which is estimated to be 6.69%.
Long-Term Debt | Rate |
Bonds 1 | 6.75% |
Bonds 2 | 6.63% |
Average | 6.69% |
Weighted Average Cost of Capital
The tax rate is estimated using the income statement of the company. Tax rate is averaged to 29%.
WACC = * Re + * Rd * (1 â€“ Tc)
Where,
- Re = cost of equity
- D = market value of the firmâ€™s debt
- V = E + D
- Tc = corporate tax rate
Or simply,
Using the formula above, the weighted average cost of capital for the firm is 5.47%.
Beta | 0.63 |
Market risk Premium | 7.50% |
Risk free rate | 3.69% |
Cost of Equity | 8.44% |
Cost of Debt | 6.69% |
Weight of Equity | 19% |
Weight of Debt | 81% |
Tax rate | 29% |
WACC | 5.47% |
Sensitivity Analysis
The weighted average cost of capital has been calculated, but there are several factors that might be volatile and will have an effect on the WACC. To evaluate the effect of such change in factor, the WACC is estimated.
The market risk premium has different assumptions, such as 5%, 6%, 7.5%, and 8% for both short-term and long-term period. WACC is analyzed under all the possible situations. It can be seen that the change in market risk premium has had a slight effect on the WACC. This is because the equity weightage in capital structure is too low.
Scenario Analysis | Â | Â | Â | Â |
Â | Market risk Premium | Cost of Equity | WACC | |
Â | 5% | 6.9% | 5.16% | |
Â | 6% | 7.5% | 5.29% | |
Â | 7.50% | 8.4% | 5.47% | |
Â | 8% | 8.8% | 5.53% |
Sensitivity analysis is also performed, specifically for the cost of debt and cost of equity variable effects on WACC. The results are variable and the WACC change as the change in each of two such variables.
5.47% | 1% | 2% | 3% | 4% | 5% | 6% | 7% | 8% | 9% | 10% | Cost of Equity |
1% | 0.77% | 0.96% | 1.15% | 1.35% | 1.54% | 1.73% | 1.93% | 2.12% | 2.31% | 2.51% | |
2% | 1.34% | 1.53% | 1.73% | 1.92% | 2.11% | 2.31% | 2.50% | 2.70% | 2.89% | 3.08% | |
3% | 1.92% | 2.11% | 2.30% | 2.50% | 2.69% | 2.88% | 3.08% | 3.27% | 3.46% | 3.66% | |
4% | 2.49% | 2.68% | 2.88% | 3.07% | 3.26% | 3.46% | 3.65% | 3.84% | 4.04% | 4.23% | |
5% | 3.06% | 3.26% | 3.45% | 3.64% | 3.84% | 4.03% | 4.22% | 4.42% | 4.61% | 4.80% | |
6% | 3.64% | 3.83% | 4.02% | 4.22% | 4.41% | 4.60% | 4.80% | 4.99% | 5.18% | 5.38% | |
7% | 4.21% | 4.40% | 4.60% | 4.79% | 4.99% | 5.18% | 5.37% | 5.57% | 5.76% | 5.95% | |
8% | 4.79% | 4.98% | 5.17% | 5.37% | 5.56% | 5.75% | 5.95% | 6.14% | 6.33% | 6.53% | |
9% | 5.36% | 5.55% | 5.75% | 5.94% | 6.13% | 6.33% | 6.52% | 6.71% | 6.91% | 7.10% | |
10% | 5.93% | 6.13% | 6.32% | 6.51% | 6.71% | 6.90% | 7.09% | 7.29% | 7.48% | 7.67% | |
Cost of Debt |
Comparable companies
For making an overall analysis and evaluating the firmâ€™s estimations with the comparable companies, the WACC is calculated for comparable companies. The risk free rates and market risk premium remain same for Heinz. Other factors were different for each of the company. The WACC for comparable companies is calculated, as shown below:
Kraft | Campbell Soup | Del Monte | ||||
Beta | 0.65 | 0.55 | 0.7 | |||
Market risk Premium | 7.50% | 7.50% | 7.50% | |||
Risk free rate | 3.69% | 3.69% | 3.69% | |||
Cost of Equity | 8.6% | 7.8% | 8.9% | |||
Cost of Debt | 5.12% | 4.36% | 6.19% | |||
Value of Equity | 58% | 22% | 59% | |||
Value of Debt | 42% | 78% | 41% | |||
Tax rate | 30% | 30% | 30% | |||
WACC | 6.5% | 4.1% | 7.0% |
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