WACC

Procter&Gamble:CostofCapital

WhyP&GsWACC?
Largeclientwantedtoenterhouseholdproductsandcompete
withP&G detergents,soaps,cleansers,andpersonalcare
Costofcapitaloftheclientnot
feasibledueto
Highlydiversifiedconglomerate
unrelatedbusiness

OverallWACCnotusefulforexisting
subsidiaries

OverallWACCnotusefulfornew
business consumerproducts

Pulpand
chemicals
1%

Sales

Foodand
beverage
s
15%

Personal
care
products
49%

Laundry
and
cleaning
products
35%

Ko =(ke*we)+(kd*(1t)*we)
Evaluate/reevaluate
thenewandexisting
investments
respectively

Earnmorethanhurdle
rate
NeedforWACC
Comparedifferent
waysoffinancingits
operations

Keyvariablefor
valuationmodels

CostofDebt?
Interest bearing debt on Books
Interest Expenses - 1989
Traded Coupon issues
YTM (close to Aaa 9.22%)
Year to maturity
Bond price

3,331
391
8.25%
9.18%
15
92.25

Why not 9.22%?

Exhibit 1 Panel D

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds
5-Year
10-Year
30-Year
Corporate Bonds by Moody's Rating
Aaa
Aa
A
Baa

7.75
7.84
7.90

8.12
8.21
8.26

8.42
8.47
8.50

8.86
9.11
9.39
9.82

8.99
9.27
9.54
9.94

9.22
9.45
9.75
10.14

CostofDebt?
Interest bearing debt on Books
Interest Expenses - 1989
Traded Coupon issues
YTM (close to Aaa 9.22%)
Year to maturity
Bond price

3,331
391
8.25%
9.18%
15
92.25

Why not 9.22%?

Exhibit 1 Panel D

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds
5-Year
10-Year
30-Year
Corporate Bonds by Moody's Rating
Aaa
Aa
A
Baa

7.75
7.84
7.90

8.12
8.21
8.26

8.42
8.47
8.50

8.86
9.11
9.39
9.82

8.99
9.27
9.54
9.94

9.22
9.45
9.75
10.14

CostofEquity
1988

Current stock price

No. of shares (Millions)
Market Cap (Millions)
Book Value of Equity
Book Value of Debt
Market Value Weight of Equity
Book Value Weight of Equity
Traget Value Weight of Equity

1989
126.25
170
21462.5
6337
7076
3364
3331
86.57%
67.99%
65%

Gorwth Rate
Past 10 Years Past 5 Years Estimated Next 5 Years
Sales
7.60
10.20
8.00
Earnings
7.00
5.90
15.50
Dividends
6.50
4.60
11.00
1989 Dec 1990 Jan 1990 Feb
US Treasury Bonds
5-Year
10-Year
30-Year
Corporate Bonds by Moody's Rating
Aaa
Aa
A
Baa

7.75
7.84
7.90

8.12
8.21
8.26

8.42
8.47
8.50

8.86
9.11
9.39
9.82

8.99
9.27
9.54
9.94

9.22
9.45
9.75
10.14

1989 Dec 1990 Jan 1990 Feb

Money Market Rates
CP (3 Months)
Eurodollar Deposits ( 3 Months)
US Treasury Bills
3 Months
1 - Year
Prime rate charged by Banks

8.32
8.39

8.16
8.22

8.22
8.24

7.63
7.21
10.50

7.64
7.38
10.11

7.74
7.55
10.00

CostofEquity
1988

Current stock price

No. of shares (Millions)
Market Cap (Millions)
Book Value of Equity
Book Value of Debt
Market Value Weight of Equity
Book Value Weight of Equity
Traget Value Weight of Equity

1989
126.25
170
21462.5
6337
7076
3364
3331
86.57%
67.99%
65%

Gorwth Rate
Past 10 Years Past 5 Years Estimated Next 5 Years
Sales
7.60
10.20
8.00
Earnings
7.00
5.90
15.50
Dividends
6.50
4.60
11.00
1989 Dec 1990 Jan 1990 Feb
US Treasury Bonds
5-Year
10-Year
30-Year
Corporate Bonds by Moody's Rating
Aaa
Aa
A
Baa

7.75
7.84
7.90

8.12
8.21
8.26

8.42
8.47
8.50

8.86
9.11
9.39
9.82

8.99
9.27
9.54
9.94

9.22
9.45
9.75
10.14

1989 Dec 1990 Jan 1990 Feb

Money Market Rates
CP (3 Months)
Eurodollar Deposits ( 3 Months)
US Treasury Bills
3 Months
1 - Year
Prime rate charged by Banks

8.32
8.39

8.16
8.22

8.22
8.24

7.63
7.21
10.50

7.64
7.38
10.11

7.74
7.55
10.00

ke =Rf +(Rm Rf)

*LongTerm
vs.Short
Term

*Current?
Historical?

*TopDown
vs.Bottom
Up
*Leveredvs.
Unlevered

NonTradedAssets?
PrivateFirms?
Reconstitutionof
firms?

*GMvs.AM

Ifnegative?

Ko =(ke*we)+(kd*(1t)*we)

Marketvs.
Book vs.
Target

LeveredandUnleveredBeta

D
= [1 + (1 - t) * ]
E
L

U
=
D
1 + (1 - t) *
E
L

EffectofLeverageonBeta

11

CreditRatingandKeyFinancialRatios
Key Industrial Financial Ratios by Credit Rating
Investment Grade
Non-Investment Grade
AAA AA A BBB
BB
B
EBIT interest coverage (x)
23.4 13.3 6.3 3.9
2.2
1
Funds from operations/total debt (%)
214.2 65.7 42.2 30.6
19.7
10.4
Free operating cash flow/total debt (%)
156.6 33.6 22.3 12.8
7.3
1.5
Return on capital (%)
35 26.6 18.1 13.1
11.5
8
Operating income/sales (%)
23.4 24 18.1 15.5
15.4
14.7
LT debt/capital (%)
-1.1 21.1 33.8 40.3
53.6
72.6
Total-debt/capital, incl. Short-term debt (%)
5 35.9 42.6 47
57.7
75.1
12

So,WhatistheWACCforP&G?

EffectiveTaxRate

2014
ITC 30.60%
HUL 23.09%
UBL 24.56%

2013
30.57%
23.42%
23.38%

2012
30.74%
22.42%
27.08%

2011
31.38%
21.49%
31.52%

2010
32.49%
21.90%
32.59%

2009
32.37%
16.80%
48.10%

2008
31.75%
17.28%
45.57%

2007
31.24%
15.18%
51.40%

2006
30.67%
13.28%
56.70%

2005
27.61%
19.37%
29.85%

IsWACCofP&GandClient
comparable?
P&Ghasa
dominantmarket
share clientisa
newentrants

Smallinsizeto
matchtheP&G

IssuesofLeverage
Differences

IssuesofBusiness
Risk