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The report presents a case about H.J. Heinz Company, a food giant, having operations around the globe,
which is concerned about the uncertainty of weighted average cost of capital. HJ needs to evaluate the
reasonableness of all assumptions used in WACC calculation including the rationality of projected cash
flows. The report carries a detailed analysis of all assumptions used in calculating WACC.

Problem Statement

The report discusses the uncertainty of weighted average cost of capital (WACC) which may have a
significant effect on the evaluation of potential performance of new products. The uncertainty occurs
due to assumptions in cash flows projections, the fluctuations of interest rates, and the risk appetite of
the market.

Case Analysis

The case highlights the importance of WACC, including a detailed discussion on each variable of WACC.
Further, it also includes an analysis of the basic assumptions used in calculating WACC and the effect of
market uncertainty on such assumptions. The report also calculates the WACC of Heinz and its other

Weighted Average Cost of Capital (WACC)

A firm derives capital from variety of sources; debt and equity, a cumulative average is required to
determine the cost of total financing. So in order to facilitate this practice; WACC is calculated to
discount the future probable cash flows of the company. WACC is an average rate of return that the
organization’s investors require from the company.

Return to debt holders is particularly fixed whereas, return to shareholders vary and are based on
management decisions because the shareholders have residual interest in the profits of the company. If
the company earns more than the WACC, then it will enhance the share value whereas if the company
earns less than WACC, it will diminish the share value.
In capital budgeting, the company can evaluate the feasibility of the project by discounting the projected
free cash flows using WACC. If the expected cash flows exceed the cost f the project than the project will
be considered as financially viable.

The report discusses the major components of WACC. The main variables are discussed below

Market Value of Debt and Equity

Cost of Debt and Equity

Beta Component

Risk Free Rate and Market Premium


Cash Flow Projections

Market Value of Debt and Equity:

In calculating WACC, market value of debt and equity is considered and not the book value because we
are raising finance from the market and it is useful to emphasize that the book value reflects the
previous investments made by the firm but it may not be realistic in today’s context, so the calculation
should focus forward rather than looking backward in historic context.

There are two major securities of H.J. Heinz which represents the major portion of company’s
outstanding borrowing. Further, the company has also other source of short-term borrowings as well, so
in determining WACC both the short and long-term portion of borrowings has been considered.

Although, the information provided in the case clearly suggest that the company’s securities are traded
in open market but in order to facilitate better presentation, an underlying assumption has been made
that the book value of the debt represents the market value of the securities. Our analysis in Appendices
1 and 2 considers both the long and short-term portion of debts from the balance sheet. On the other
hand, market value of the equity has been calculated by multiplying the share price at the end of fiscal
year with the outstanding shares.

Cost of Debt and Equity:

Cost of debt and equity represents the required return demanded by the debt and common
shareholders on their investment and to bear specific level of risk on their investments. The discount
rate used in valuation of the project should reflect the time frame of the cash flows, so an important
point to consider is that whether short or long-term interest rate is used. Short-term rates are matured
soon and fail to consider appropriate level of risk whereas the long-term rates are more volatile and are
market sensitive.

As shown in our appendices, the cost of debt has been calculated by considering the interest expense on
the outstanding debts whereas for calculating the cost of equity, Capital Asset Pricing Model (CAPM) has
been adopted which states that the return is based on risk free rate and market premium after
considering the risk factor..................

Situation Analysis

General Environmental Analysis

H.J. Heinz specialized in quality food products with over 150 brands. They have a globalbusiness which is
facing seeming turmoil. This is in part because of the financial crisis. Theirshare price is seeing low
interest rates. We must further analyze their competitors and theirweighted average cost of capital.
Furthermore, we will need to analyze the company’soutstanding borrowing. Therefore the WACC for
short term and long term borrowing will needto be considered.

Industry Analysis

As previously identified it is apparent that there is global turmoil. Various factors affectthe weighted
average cost of capital. This includes analyzing the Market Risk Premium, cost ofdebt, cost of equity, and
their relativity to the market. To better determine the risk and volatilityof the stock we need to obtain a
measurable Beta. This give an investor an idea whether the priceof the security is volatile or not as
compare to other securities in the market. The beta of Heinzrepresents .62 whereas for Kraft, Campbell,
and Del Monte represent .58, .32 and 0.72. Beta isdirectly correlated to risk. The higher `the beta, the
higher the risk. Therefore, Heinz is a mediumrisk company in comparison to those in their industry.
Campbell being the lowest risk takerwith .32 beta. H. J. Heinz Company is a food manufacturing and
distributing company. Itmanufactures products in three categories that are Ketchup and sauces, Meals
and Snacks andInfant Nutrition. Heinz is a global powerhouse; it operates in more than 200 countries.
Thebusiness segments of the company are based primarily on region: North American
ConsumerProducts, U.S. Food service, Europe, and Rest of World. However, Heinz is now focusing on
the emerging market, which is in the growing phase. Heinz is in the competitive market as there
areother rivals who are larger than Heinz; however, it is still trying to cross them.

n conclusion, it is recommended that Heinz take a market risk premium of about 7.50%.with beta at .441
they will see an estimated WACC of 6.04% and with a beta of .62 they will seea WACC of 7.08%. The
WACC ranges from 5.2% to 6.55% with various market risk premiums.With 7.5% they will not be too
aggressive nor too conservative. Furthermore, the financial crisishave cause bond rates to go low, but
have also caused inflation to be low. Because of this there isno need to adjust the risk free rate to reflect
market conditions