At the time of the case (May 2010), H. J. Heinz was experiencing uncertain
economic times. Most notably, this uncertainty manifested in discussion
about the company’s weighted average cost of capital (WACC). This was
an important discussion to have since the cost of capital greatly influenced
how the company chose to invest, and stood to influence the company’s
corporate strategies and competitiveness in the future.
The uncertainty of the times was significantly reflected in the company
stock price over the period 2008 to 2010. Over this period, the price
fluctuated from $47 at FYE 2008, down to $34 at FYE 2009 and back up to
$47 at FYE 2010. Accordingly, Heinz was considering whether or not to
adjust their cost of capital to reflect these changes as they occurred. This
gives rise to two questions:
To what degree should these stock price changes affect cost of capital?
How often should the cost of capital be re-estimated?
To address these questions, we first estimated Heinz’s WACC at the time
under the given market conditions
In order to prepare our estimation for the WACC, we first made educated
assumptions for the variable inputs of the WACC equation. Our
assumptions and source behind each are as follows:
Table 1: The assumptions and corresponding source, used in the Heinz
WACC estimation
Assumption Source
Risk Free Rate: 4.5 % Based on the 30-year Treasury Yield as of April 2010
(Exhibit 3 of case)
Market Risk Premium: 7.5% Based on long-term estimates (case, page 5)
Beta: 0.62 Based on 5 year average (case, page 5)
Cost of Equity: 9.18% Calculated using CAPM and above data
Cost of Debt: 3.16% Calculated using bond data (Exhibit 3)
Value of Equity: $14,890,130,300 Calculated based on share price of
$46.87, multiplied by outstanding shares of 317.69 million (Exhibit 2)
Value of Debt: 4,559,152 In lieu of a market value, the book value of short–
term borrowings, current portion of long-term debt, and long term debt
(Exhibit 2)
Tax Rate: 35% Based on average corporate tax rate
The use of the 30-year treasury yield is to ensure that there is duration
matching between the return estimated on risk free assets, and the
investment time horizon for Heinz, which is assumed to be over long
periods of time. In terms of the Market Risk Premium and Beta, we elected
to use the most long-term estimates available since these provide the most
accurate representation of the market by avoiding a bias to more current
market fluctuations. To calculate the cost of debt, the yield to maturity
(YTM) of the two bonds given in exhibit 3 of the case (Appendix 1). The
average of the two bonds was taken since the case indicated that these
were representative of the company’s outstanding borrowings, and thus the
assumption was made that each bond represented 50% of the company’s
debt.
The Value of Equity was calculated based on the market value of the
outstanding shares of Heinz. However, similar data on market value for the
firm’s Value of Debt was not provided, and as a proxy the sum of the book
values of the debt as described in Table 1 was used.
Based on these assumptions, we believe the best estimate for H.J. Heinz’s
WACC is 7.51% (Appendix 2). While we believe this WACC gives the most
accurate picture of the company, we recognize that the numerous
assumptions we made directly impact the final output. Therefore, we
elected to conduct sensitivity checks around certain assumptions that lend
