Essay about Heinz: Estimating the Cost of Capital

2330 Words Jan 6th, 2014 10 Pages
H.J. Heinz Company Case:
Cost of Capital in Times of Uncertainty

Group 10

Alan Ho 20349978

Saraniya Paramanathan 20332829

Christopher Abeleda 20335744

Nathanael Cheung 20345672

Reuban Nadesan 20346511

To: Board of Directors Committee, H.J. Heinz Company
From: Group 10 Consulting
Date: July 7, 2011
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Subject: Weighted Average Cost of Capital Recommendation
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Heinz has reached an unstable point in its business cycle and must calculate an appropriate cost of capital during these uncertain times. The cost of capital is an essential measure in determining the cost of a company’s capital structure. It is the
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Please refer to Appendix 2 for other considerations for cost of equity calculations. Most firms 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 the expected market return of the stock. These values are all based on forward-looking data. The model dictates that shareholders require a return equal to the return from a risk-free investment plus an equity risk premium for bearing extra risk. Refer to Appendix 1 for a full breakdown of the CAPM formula.
The risk-free rate recommended under the CAPM model is the yield on long-term (i.e. 10+ years) T-bills. When choosing the T-bill term, it is important for it to closely represent the time frame used for Heinz’ required rate of return.
A common practice to determine the firm’s beta is to draw from historical data from published sources or compare numbers to competitors. In this case, Heinz can compare to Kraft, Campbell Soup and Del Monte and use professional judgement in determining the stock’s sensitivity to the market. A stock’s beta can be determined using a formula as well.
As mentioned earlier, the theory uses a forward-looking risk premium which reflects current market conditions that are sensitive to changes. Although this is the case, research on various companies demonstrates that experts infer future…