Costs of Capital Exercise
XiaomingXu
CostsofCapitalSTUDENT.xlsxCosts of Capital
| Costs of Capital | ||||||||||||||||
| Ke = Cost of Common Equity | ||||||||||||||||
| Ku = Unlevered Cost of Capital (sometimes called the Unlevered Cost of Equity) | ||||||||||||||||
| Kpfd = Cost of Preferred Equity | ||||||||||||||||
| Kd = Cost of Debt (NOTE: This is the before-tax cost of debt) | ||||||||||||||||
| WACC = Weighted Average Cost of Capital | ||||||||||||||||
| Please Note: | The costs of capital are all related, and the components connect. | |||||||||||||||
| Each rate represents a demanded return from a different point of view. | ||||||||||||||||
| All of the rates represent the same company, so the risk of the company should be reflected in each. | ||||||||||||||||
| The rates will fall into this order: Rf < Kd < WACC < Ku < Ke. | ||||||||||||||||
| Universal inputs for costs of capital | ||||||||||||||||
| 1.91% Michael Dimond: from treasury.gov for date of interest | Rf (Risk-free Rate) | source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrateYear&year=2020 TREASURY 20-Yr CMT on filing date | ||||||||||||||
| 5.50% Michael Dimond: Estimated. Consider the implied market return (Rf+MRP) to make sure this is reasonable. | Market Risk-Premium (MRP) | |||||||||||||||
| High-level company-specific inputs for costs of capital | ||||||||||||||||
| $ 142.32 | Adjusted Close on date of interest (filing date, in this case) | |||||||||||||||
| 1,389,544,618 | Shares outstanding on date of interest | |||||||||||||||
| MV Equity | ||||||||||||||||
| 21.04% Michael Dimond: Use the same rate used in NOPAT computation for subject company. | Tax Rate | |||||||||||||||
| Comparable Firms and Unlevered Beta (also multiples for relative valuation) | ||||||||||||||||
| Ticker | Beta | Debt | Equity (Market Cap) | Tax Rate | Unlevered Beta Michael Dimond: Unlevered Beta = Beta divided by (1+ D/E*(1-tax rate)) | P/E ratio | P/S ratio | EV/EBITDA ratio Michael Dimond: Enterprise Value to EBITDA |
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| Coca Cola | KO | 0.58 | 52.87 Michael Dimond: Given in billions | 209.29 Michael Dimond: Given in billions | 14.77% | 25.23 | 6.29 | 19.01 | ||||||||
| Monster Beverage Corp. | MNST | 1.11 | 0.02 Michael Dimond: Converted from millions to billions | 48.38 | 23.33% | 41.28 | 11.13 | 29.00 | ||||||||
| Keurig Dr Pepper | KDP | 0.61 | 14.86 | 45.03 | 22.50% | 34.95 | 3.95 | 20.94 | ||||||||
| Anheuser-Busch InBev SA/NV | BUD | 1.24 | 112.67 | 135.91 | 21.81% | 9.87 | 2.89 | 31.88 | ||||||||
| Molson Coors Beverage Co. | TAP | 1.16 | 8.79 | 11.40 | 33.96% | 19.53 | 1.16 | 11.49 | ||||||||
| Campbell's Soup | CPB | 0.51 | 6.32 | 14.06 | 21.71% | 19.26 | 1.60 | 12.31 | ||||||||
| Conagra | CAG | 0.80 | 9.54 | 16.54 | 20.75% | 14.92 | 1.44 | 11.68 | ||||||||
| Kellogg Co. | K | 0.60 | 9.21 | 20.29 | 22.43% | 17.11 | 1.51 | 12.09 | ||||||||
| Kraft Heinz | KHC | 1.01 | 28.52 | 39.11 | 27.36% | 22.23 | 1.52 | 26.54 | ||||||||
| Mondelez Int'l | MDLZ | 0.63 | 20.77 | 81.83 | 33.68% | 26.99 | 3.16 | 20.70 | ||||||||
| Average of Comparable Firms | <--Average | |||||||||||||||
| Median of Comparable Firms | <--Median | |||||||||||||||
| Unlevered Cost of Capital (Ku) | ||||||||||||||||
| - 0 Michael Dimond: From "Comparable Firms" table | Unlevered Beta | |||||||||||||||
| Ku (Unlevered Cost of Capital) | Unlevered Cost of Capital is computed using a CAPM variation: Ku = Rf + Unlevered_Beta * (MRP) | |||||||||||||||
| Cost of Debt (Kd) and Market Value of Debt | ||||||||||||||||
| The most accurate way is to find the YTM on outstanding public debt for the company | ||||||||||||||||
| 2.426% Michael Dimond: median from source: https://finra-markets.morningstar.com/BondCenter/Results.jsp?debtOrAssetClass=3%2C6&issuerName=&traceOrCusipOrBloomberg=PEP&state=&cusipOrFinraSymbol=&showResultsAs=B&spdsType=&treasuryOrAgencyType=&subProductType=&debtInstrumentType=&securityDescription=&industryGroup=&convertibleflag=&industrySubtype=&sourceOfPayment=&proceedsUse=&issuingAgency=&collateralOrAssetType=&couponType=&detailedCouponType=&couponRate=&interestFrequency=&interestType=&maturityDate=&moodysRating=&standardAndPoorsRating=&traceInvestmentGrade=&beginningOrNextCallDate=&poolNumber=&masterDealId=&trancheId=&tradeDate=&tradeYield=&tradePrice=&agency=&productDescription=&maturityCode=&settlementMonth=&productType=&amortizationType=&maturity=&coupon=&weightedAverageCoupon=&weightedAverageMaturity=&weightedAverageLoan=&averageLoanSize=&loanToValueRatio=&SubProductType=ABS&subProductAssetDescription=&rule144aindicator=&showAdvancedSearch=hide&postData=%7B%22Keywords%22%3A%5B%7B%22Name%22%3A%22debtOrAssetClass%22%2C%22Value%22%3A%223%2C6%22%7D%2C%7B%22Name%22%3A%22showResultsAs%22%2C%22Value%22%3A%22B%22%7D%2C%7B%22Name%22%3A%22traceOrCusipOrBloomberg%22%2C%22Value%22%3A%22PEP%22%7D%5D%7D | Yield on Bonds | |||||||||||||||
| We could also use "synthetic ratings" to estimate the cost of debt… | ||||||||||||||||
| not yet… | based on TIE (Times Interest Earned ratio) Michael Dimond: See Damodaran pp 211-215 for his discussion. |
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| not yet… | based on Altman Z-Score Michael Dimond: http://pages.stern.nyu.edu/~ealtman/z-metrics.pdf http://pages.stern.nyu.edu/~ealtman/3-%20CopCrScoringModels.pdf https://www.mckinsey.com/business-functions/risk/our-insights/resilience-in-a-crisis-an-interview-with-professor-edward-i-altman# https://www.researchgate.net/publication/228252704_Bankruptcy_Prediction_Models_and_the_Cost_of_Debt |
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| … and we might cover these in a later lesson. | ||||||||||||||||
| From the alternatives, choose the rate which best reflects the risk the company poses to lenders. | ||||||||||||||||
| 2.43% | Cost of Debt | |||||||||||||||
| The cost of debt is necessary to estimate the market value of total debt | ||||||||||||||||
| Market Value of Debt | ||||||||||||||||
| Balance Sheet Debt | ||||||||||||||||
| PV | Market Value of Debt on B/S, estimated using Damodaran's method (see pg 219) | |||||||||||||||
| PMT | 1,135 | Interest Expense from Income Statement | ||||||||||||||
| FV | 32,068 | BV Debt from Balance Sheet | ||||||||||||||
| N | 20 | Assumed Years to maturity | ||||||||||||||
| Operating Leases | ||||||||||||||||
| PV of Operating Lease Expenses | ||||||||||||||||
| Expected Op. Lease Payments: | ||||||||||||||||
| Y1 | Y2 | Y3 | Y4 | Y5 | Y6 | Y7 | ||||||||||
| 501 | 327 | 327 | 150 | 150 | 308 | |||||||||||
| Based on data listed under "Credit Facilities and Long-Term Contractual Commitments" in Pepsico's 10-k | ||||||||||||||||
| Levered Beta and Cost of Equity (Ke) | ||||||||||||||||
| D/E Ratio (based on market values) | ||||||||||||||||
| Levered Beta ("Bottom-up Beta") | ||||||||||||||||
| Ke (Cost of Equity … Common Equity) | CAPM: Ke = Rf + Levered_Beta * (MRP) | |||||||||||||||
| Weighted Average Cost of Capital (WACC) | ||||||||||||||||
| Value | Weight | |||||||||||||||
| - 0 | MV Debt | Wd =MV Debt / MV Total Capital | ||||||||||||||
| - 0 | MV Equity | We =MV Equity / MV Total Capital | ||||||||||||||
| - 0 | MV Pfd Stock | Wpfd = MV Pfd Stock / MV Total Capital | ||||||||||||||
| MV of Total Capital | ||||||||||||||||
| WACC (Weighted Average Cost of Capital) | ||||||||||||||||
| Reality Check: Do the rates make sense? | ||||||||||||||||
| Do they adequately reflect the uncertainty of the cash flows we are valuing? | ||||||||||||||||
| Remember | Rf < | Kd < | WACC < | Ku < | Ke | |||||||||||
| 1.91% | 2.43% | 0.00% | 0.00% | 0.00% | ||||||||||||
| ERROR:#DIV/0! Michael Dimond: This is an alternative way to estimate the unlevered cost of capital. It is sometimes helpful to give a sense-check to unlevered beta. |
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Michael Dimond: From "Comparable Firms" table |
Michael Dimond: Computed using CAPM and Unlevered Beta |
Michael Dimond: from treasury.gov for date of interest |
Michael Dimond: Estimated. Consider the implied market return (Rf+MRP) to make sure this is reasonable. |
Michael Dimond: Computed using Hamada's formula: Unlevered_beta times (1+D/E(1-t)) |
Michael Dimond: Computed using CAPM and Levered Beta |
Michael Dimond: median from source: https://finra-markets.morningstar.com/BondCenter/Results.jsp?debtOrAssetClass=3%2C6&issuerName=&traceOrCusipOrBloomberg=PEP&state=&cusipOrFinraSymbol=&showResultsAs=B&spdsType=&treasuryOrAgencyType=&subProductType=&debtInstrumentType=&securityDescription=&industryGroup=&convertibleflag=&industrySubtype=&sourceOfPayment=&proceedsUse=&issuingAgency=&collateralOrAssetType=&couponType=&detailedCouponType=&couponRate=&interestFrequency=&interestType=&maturityDate=&moodysRating=&standardAndPoorsRating=&traceInvestmentGrade=&beginningOrNextCallDate=&poolNumber=&masterDealId=&trancheId=&tradeDate=&tradeYield=&tradePrice=&agency=&productDescription=&maturityCode=&settlementMonth=&productType=&amortizationType=&maturity=&coupon=&weightedAverageCoupon=&weightedAverageMaturity=&weightedAverageLoan=&averageLoanSize=&loanToValueRatio=&SubProductType=ABS&subProductAssetDescription=&rule144aindicator=&showAdvancedSearch=hide&postData=%7B%22Keywords%22%3A%5B%7B%22Name%22%3A%22debtOrAssetClass%22%2C%22Value%22%3A%223%2C6%22%7D%2C%7B%22Name%22%3A%22showResultsAs%22%2C%22Value%22%3A%22B%22%7D%2C%7B%22Name%22%3A%22traceOrCusipOrBloomberg%22%2C%22Value%22%3A%22PEP%22%7D%5D%7D |
Michael Dimond: Market Capitalization as of the date of interest. NOTE: This was scaled to match dollar figures from financial statements. |
Michael Dimond: See Damodaran pp 211-215 for his discussion. |
Michael Dimond: http://pages.stern.nyu.edu/~ealtman/z-metrics.pdf http://pages.stern.nyu.edu/~ealtman/3-%20CopCrScoringModels.pdf https://www.mckinsey.com/business-functions/risk/our-insights/resilience-in-a-crisis-an-interview-with-professor-edward-i-altman# https://www.researchgate.net/publication/228252704_Bankruptcy_Prediction_Models_and_the_Cost_of_Debt |
Michael Dimond: Use the same rate used in NOPAT computation for subject company. |
Michael Dimond: WACC = We*Ke + Wd*Kd*(1-t) where: We = MV Equity / MV Total Capital Wd = MV Debt / MV Total Capital If preferred stock exists, include factors for weight of preferred stock and required return for preferred stock: WACC = Wpfd*Kpfd + We*Ke + Wd*Kd*(1-t) |
Michael Dimond: Given in billions |
Michael Dimond: Given in billions |
Michael Dimond: Converted from millions to billions |
