Introduction of HJ Heinz Company
HJ Heinz Company, is a famous food company based in USA. The company has a portfolio of world class food and holding the first place in various markets around the world. According to 2007 annual report, Heinz reported a profit which constitutes up to $ 2.5 billion. The brands and products of Heinz are considered cultural icons in various parts of the world.
HJ Heinz Company is an American incorporated company that was established in 1869. Heinz is now one of the most top brands in the market and sells more than 1,000 products ranging from tomato sauce to meals and snacks. In the period of 2007, HJ Heinz Company and its subsidiaries wereengaged in various production and marketing of processed foods like tomato sauce, beans, soups and baby foods. The company sells its products through its own agents, sales organizations and distributors. It operates in North America, Asia-Pacific and Europe.
The cost of capital is a critical measure used in capital budgeting process and determines which projects are profitable for the company. The most common way to estimate the cost of capital in companies is the Weighted Average Cost of Capital method, as it represents both debt and equity as sources of finance. This measure focuses on current conditions in financial markets and therefore ignores irrelevant historical costs. There are two main components which WACC uses to estimate the cost of a company i.e. the cost of debt and cost of equity.
The cost of debt can be measured easily. It consists of the yield to maturity of long-term debt for the organization. This rate is then multiplied by the difference of -1 of the marginal tax rate to determine the tax benefit that has been received from interest paid. The interest that has been paid is deductible for tax purposes, which ultimately decreases the cost of debt of the company.The cost of equity is more subjective, because there is no explicit required return on equity. Most businesses use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The components that make up the CAPM include: the risk-free rate, the beta of the security and performance of expected stock market, these values â€‹â€‹are based on data relates to the future. The model states that shareholders demand a return are equal to the yield of a risk-free investment plus a risk premium of the actions that carried an additional risk.
The CAPM risk-free rate is the yield in the long term of10 years Treasury bills. By choosing the term treasuryis important to represent close time frame used for the required rate Heinzâ€™ return.
A common practice to determine the beta of the company is to extract historical data from published sources or compare numbers to the competitors. Over here, Heinz is comparable to Kraft, Campbell Soup and Del Monte and use professional judgment in determining the sensitivity of the action in the market. Beta of a stock can be determined using a formula well.
Answer #1 – WACC for Heinz
Weighted average cost of capital (WACC) of Heinz is 6.53% and 7.65%in 2010 and 2009 respectively. WACC depends on the following variables: Heinz’s beta, the risk-free rate, the risk premium, and the marginal effective tax rate and the cost of debt.
Beta. The beta of the company isdetermined at a constant rate of 0.62 for the year 2010 and 2009. Most of the sources were evaluated by estimatingthe beta of the company based on the previous five years of data. It is based on a large sample of five years and on the organizationrecent performance. This methodology contributes in determining the most useful beta in predicting the current volatility. The beta is also consistent with the change in stock price of the company where it is starting to track market movements.
Risk-free rate. The companyâ€™srisk-free rate of return is determined to be 5.53% and 7.44% for the year 2010 and 2009 respectively. These are the rates of government bonds used in the United States for 10 years. Rates on government bonds of 10 years were used because they are widely regarded as the risk free form of debt and is a more realistic in the retaining the profitability of the investments made by the companies represented.
Risk premium.The risk premium is determined at a constant rate of 8% per year. There was a great diversity of opinions regarding the risk premium ranging from 5.0% to 8%. It was appropriate to use shorter periods of time since the economy was experiencing a recession; using previous years in the premium does not reflect the current state of the economy. The rate of 8 % premium represents the current state of the economy. Equity has more risk as due to an economic recession, the businessâ€™s performance typically declines,and therefore, investors are in risk when they buy shares………………………………….
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