Integrative Case: Henkel AG Cost of Capital
Valuation
The Cost of Capital at Henkel AG
Professor David Wessels © 2010
The Wharton School of the University of Pennsylvania
3620 Locust Walk, Philadelphia, PA 19104
Integrative Case: Henkel AG Cost of Capital
The Cost of Capital at Henkel
•To value Henkel using discounted cash flow (DCF) and to evaluate
Henkel’s ability to create value, we need a robust estimate of the
company’s cost of capital.
• Based on today’s low interest rates (the 10-year German Treasury trades at
just 3.4 percent), we estimate Henkel’s after-tax cost of capital at 6.6
percent. This estimate is based on a cost of debt of 3.2 percent (using a
default rating of A–), a cost of equity of 7.5 percent (using a relevered
industry beta of 0.82), and a debt-to-value ratio of 22.0 percent.
•In this presentation, we step through the calculation of each component.
We start with the cost of debt, followed by the cost of equity, and conclude
with a short discussion on the company’s capital structure.
Valuation: Measuring and Managing the Value of Companies 2
Integrative Case: Henkel AG Cost of Capital
The Cost of Capital
Valuation: Measuring and Managing the Value of Companies 3
•Yield to
•German
company
•Yield to
•Estimated
We assume Henkel will
maintain its current 22.0%
•We estimate the after-tax cost of capital for Henkel at 6.6 percent. The cost of capital is
historically low, driven primarily by low interest rates (only 3.4 percent for 10-year
German Treasuries) and a low beta for Henkel (estimated at 0.82).
Cost of capital:
After-tax cost of
Cost of equity:
Integrative Case: Henkel AG Cost of Capital
Credit Ratings
•Since Henkel does not carry long-term debt, use the company’s credit rating to
determine the cost of debt. As of its last rating, the company was rated A–,
which translates to a yield to maturity of 4.63 percent.
Henkel Credit Ratings
Rating Actions
S&P
Agency Date Rating Equivalent
Moody’s Jul–09 A3 A-
S&P May-09 A- A-
S&P Apr–07 A A
Fitch Nov-05 A- A-
S&P Oct-04 A- A-
4.13%
4.49%
4.52%
4.74%
5.08%
AA
AA–
A
BBB+
BBB
Yield by Debt Rating
European Industrials, 2009
A-
estimated at
4.63%
Integrative Case: Henkel AG Cost of Capital
After-Tax Cost of Debt
•Since interest is tax deductible, and
this deduction is not included in
free cash flow or ROIC, it must be
tax rate of 31 percent. Therefore,
we reduce the cost of debt from 4.6
percent to 3.2 percent.
0%
10%
20%
30%
50%
2005
2006
2007
2008
2009
Henkel AG
Marginal tax rate
cost of debt = (1 –31%) (4.63%)
Integrative Case: Henkel AG Cost of Capital
The Risk-Free Rate
•To calculate the cost of equity for
Henkel AG, we start with a euro-
denominated 10-year German
Treasury rate.
flows and the cost of capital).
Valuation: Measuring and Managing the Value of Companies 6
3.9%
4.6%
4.2%
1%
4%
5%
Treasury Rates
Yields to maturity, 2009
10–YearGerman Treasury
Integrative Case: Henkel AG Cost of Capital
Cost of Equity: Unlevered Beta
•To compute the cost of equity, we
rely on the capital asset pricing
model (CAPM), which in turn
requires beta. To calculate beta,
we first unlevered each company in
• Henkel’s unlevered beta of 0.59 is
Valuation: Measuring and Managing the Value of Companies 7
Henkel AG Cost of Capital
European HPC Betas1
OLS Bloomberg Debt–to Unlevered
Company Beta
Adjustment2Equity Beta
Beiersdorf AG 0.29 0.53 –0.15 0.62
Givaudan SA 0.41 0.60 0.33 0.46
Henkel AG 0.73 0.82 0.28 0.64
Reckitt Benckiser plc 0.20 0.47 0.00 0.47
Svenska Cellulosa AB 0.73 0.82 0.63 0.50
Unilever plc 0.52 0.68 0.14 0.60
0.64
Integrative Case: Henkel AG Cost of Capital
Beta Calculations by Segment
•To calculate a cost of capital by
segment, we look to industry
competitors on a broader scale.
Adhesives (0.71). This is consistent
with the stability of consumer staples
and the cyclical nature of adhesives.
Henkel AG Cost of Capital
Segment betas
OLS Bloomberg Debt–to Unlevered
Company Beta Adjustment Equity Beta
Henkel AG 0.73 0.82 0.28 0.64
0.44
Estee Lauder 0.90 0.93 8.7% 0.86
0.67
3M Company 0.62 0.74 7.1% 0.69
Avery Dennison 0.91 0.94 45.3% 0.65
Fuller (H B) 0.87 0.91 16.7% 0.78
0.71
Integrative Case: Henkel AG Cost of Capital
•To determine the cost of equity, we
relever industry betas to Henkel’s debt–
to-equity ratio. We then apply the
capital asset pricing model:
Cost of Equity by Segment
f m f
Cost of equity = r +bE R – r
using a risk-free rate of 3.38 percent
and a market risk premium of 5 percent.
•Based on a levered beta of 0.64, we
7.5%
6.2%
7.7%
Henkel AG
Laundry &
Home Care
Cosmetics
& Toiletries
Cost of Equity
Discount rate, based on 2009 comparables
Integrative Case: Henkel AG Cost of Capital
Capital Structure
•To create the weighted average cost of capital, we weight the cost of debt and
cost of equity by the market values of debt and equity. For Henkel, debt
comprises 22.0 percent of the total enterprise value.
4.2
0.8
5.0
1.2
3.8
13.4
17.2
0
5
10
15
20
Total
Unfunded
Debt &
Cash
Net debt
Market
Enterprise
$ billions
Henkel AG Capital Structure
$ billions
Henkel AG Cost of Capital
Capital Structure
$ billions percent
Net debt 3.8 22.0%
Market capitalization 13.4 78.0%
Enterprise value 17.2 100.0%