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Henkel Integrative Case: Part IV
Cost of Capital
Introduction
To value a company using enterprise discounted cash flow (DCF), we discount free cash flow by
the weighted average cost of capital (WACC). The weighted average cost of capital represents
the opportunity cost that investors face for investing their funds in one particular business instead
of others with similar risk. To determine the weighted average cost of capital, calculate its three
components: the cost of equity, the after-tax cost of debt, and the company’s target capital
structure. Since none of the variables is directly observable, we employ various models,
assumptions, and approximations to estimate each component.
Instructions
The cost of equity is built on the three factors: the risk-free rate, the market risk premium, and a
company-specific risk adjustment. The most commonly used model for this estimate is the
capital asset pricing model (CAPM). To determine the CAPM, we need to estimate a risk-free
rate, the market risk premium, and the market beta.
a. To determine the risk-free rate, please use Treasury data from the “Select Market
Data” spreadsheet. On the “Yields” tab, you will find yields to maturities for U.S. and
German Treasury rates. For Henkel AG, which Treasury rate at which maturity is
most appropriate to use in valuing the company?
b. To determine Henkel’s corporate beta, unlever (and relever) the ordinary least squares
(OLS) market betas for each company in the European Household and Personal Care
segment. Prices can be found on the “Prices” tab of the “Select Market Data”
spreadsheet. To determine the OLS market beta, regress 10-year monthly returns
against the MSCI World index denominated in the same currency. In Excel, this can
be done using the “SLOPE” formula. Next, unlever the market beta using each
company’s year-end debt-to-equity ratio and the formula: bu = be/(1 + D/E). To
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determine Henkel’s corporate beta, relever the average industry beta using Henkel’s
year-end debt-to-equity ratio. Repeat this process for each of Henkel’s divisions.
c. Assume the market risk premium equals 5 percent.
Henkel does not carry debt beyond five years. Therefore, we determine the after-tax cost of
debt using a portfolio of similarly rated bonds. To determine the cost of debt:
a. Use the same risk-free rate used to determine the cost of equity.
b. Add a default premium based on the company’s debt rating by Standard & Poor’s.
Yields by credit rating can be found on the “Yields” worksheet of the “Select Market
Data” spreadsheet. Henkel reports its debt rating on its investor relations web site at
www.henkel.com/investor-relations/credit-ratings-11952.htm. If the company’s rating
is between reported portfolios, interpolate between the nearest ratings.
c. To determine Henkel’s marginal tax rate, use the tax reconciliation table in the annual
report. Set the marginal tax rate equal to the “Tax rate on income.”
To complete the cost of capital, weight the after-tax cost of debt and cost of equity using the
company’s year-end capital structure (found in the “Select Market Data” spreadsheet).
Helpful Page Locations, Henkel 2009 Annual Report
Taxes on income (the tax reconciliation table) can be found in note 9 starting on page 92.
Required Spreadsheets
Select Market Data
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