Instructions
The cost of equity is built on the three factors the nsk-free rate the market nsk premium and a compam-specific nsk adjustment The most commonly used model for this estimate is the capital asset pricing model (CAPM) To deternane the CAFM we need to estimate a nsk-free rate the market nsk premium and the market beta
1 To determine the nsk-free rate. please use Treasury data from the -Select Market Data spreadsheet On the "Yields tab. you will find yields to =aunties 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
2 To determine HenkelS corporate beta. unleier (and releker) the ordinary least squares (OLS) market betas for each company in the European Household and Personal Care segment Pnces can be found on the 'Prices" tab of the 'Select Market Data- spreadsheet To detenrine 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' formda Next unlever the market beta using each company's year-end debt-to-equity ratio and the formula bu = be/1(+D/E) To determine Henkel's corporate beta rele.er the a ierage industry beta using Henkeks year-end debt - to equity ratio Repeat this process for each of Henkels divisions
3 Asasne the market nsk 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 sindady rated bonds To determine the cost of debt
1 Use the same nsk-free rate used to deter one the cost of equity
2 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' worldbeet of the 'Select Market Data spreadsheet Henkel reports its debt rating on its investor relations web site at henkel conrimestor-relations-crecht-ratings-11952 htm If the company-5 rating is between reported portfolios interpolate between the nearest ratings
3 To determine Henkers marginal tax rate, use the tax reconciliation table in the annual report Set the =romal lax 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
REVIEW QUESTIONS
1. Define contingent net present value (NPV). Outline and explain the differ-ences between standard and contingent NPV.
2. Identify the value drivers embedded in a "rear option and how they might interact.
3. Assume a company runs a plant for which the value one year from now is either $1,000 if market growth is positive or $250 if market growth is negative.
The probability of positive market growth is 60%, and the prob-ability is 40% for negative market growth. At any time, the company can choose to close the plant and collect the scrap value of $285 if scrapped today or $300 if scrapped in one year The cost of capital for the plant is 10% and the risk-free rate is 5%. Estimate the value of the plant using the stan¬dard NPV, decision tree analysis (DTA), and real-option valuation (ROY) valuation models. Explain the differences in results.