H.J.Heinz: ESTIMATING THE COST OF CAPITAL IN UNCERTAIN TIMES...Darden Case Solution and Analysis

1. H.J.Heinz: ESTIMATING THE COST OF CAPITAL IN UNCERTAIN TIMES
Darden Case Solution & Analysis
Presented To: Dr Safia Nosheen
Presented By:
Iqra Ch
Sadia Butt
Adeel Attari
SBE, University of Management & Technology

2. Contents
 Presenter1: Iqra
 Introduction
 Background
 Company’s overview
 Issues faced by
Heinz
 Heinz stock price
 Problem statement
 Presenter 2: Sadia
 Questions Overview
 Question 1 Solution
 Question 2 Solution
Presenter 3: Adeel
Questions Overview
Question 3 Solution
Comparative analysis
discussion
Concluding Remarks

3. Introduction
 H. j. Heinz Company was incorporated in Pennsylvania on
January 1869. In 1905, it succeeded to the business of the
partnership operating under the same name which had
developed from a food business founded in 1869 in
Sharpsburg Pennsylvania.
 The company and its subsidiaries manufactured and
marketed an extensive line of processed and minimally
processed food and related products throughout the world.

4. Important Facts & Top Selling Brands
 Get inspired by an advertisement of 21 STYLES OF SHOES
 Started with a slogan of 57 Varieties
 Became Industry giant by 2010
 $10 billion Revenues
 29600 employees
 150 products holding first or Second position in Global markets
 Heinz Ketchup is top selling brand in US with $1.5million or
650million bottles sale
 Weight Watchers is leader in Dietary Products with 1.5 million cans
sale per day in Britain

5. More About Company
 Companies products were organized into two core
business categories:
 Meal Enhancers & Meal snakes
 Heinz distributed its products via its own sales
forces, independent brokers, agents and
distributers to wholesale, cooperative and
independent grocery accounts, mass merchants
and superstores, pharmacies, food service
distributors including schools and government
agencies.
 In February 2013 purchased by Berkshire
Hathaway and the Brazilian 3G Capital for $23
billion
 On March 25, 2015, Kraft announced its merger
with Heinz, arranged by Berkshire Hathaway and
3G Capital.
 The resulting Kraft Heinz Company is the 5th
largest food company in the world.

6. Issues behind Heinz
 The central problem for Heinz was calculating the companies weighted average
cost of capital (WACC) which may have a significant effect on the evaluation of
potential performance of new products.
 There were three reasons why the cost of capital was difficult to calculate:
First Reason: (Stock price fluctuations
 Stock price fluctuated within two years span
 In 2008 stock price was $47 then fell down to
$34 and up back to $47 in 2010.
 There was a debate whether to update the
changes because the price eventually come
back to $ 47.

7. Issues behind Heinz
 The central problem for Heinz was calculating the companies weighted average
cost of capital (WACC) which may have a significant effect on the evaluation of
potential performance of new products.
 There were three reasons why the cost of capital was difficult to calculate:
Second Reason: (Low Interest
Rates)
 Interest rates remained low and there were
concerns to update the cost of capital
because the low interest rates would lower
the cost of capital, which would led to a lot
projects being accepted.

8. Issues behind Heinz
 The central problem for Heinz was calculating the companies weighted average
cost of capital (WACC) which may have a significant effect on the evaluation of
potential performance of new products.
 There were three reasons why the cost of capital was difficult to calculate:
Third Reason: (Sensing Appetite for the risk in the
market has changed)
 With the recession that took place the chances of consumers
taking risk changed but there was no consensus as to how this
would effect the cost of capital, and if it did what would be the
impact?
 Heinz had to deal with stiff competition from the likes of Kraft
Foods, the largest U.S based food and beverage company,
Campbell Soup the iconic canned food maker, and Del Monte
Foods one of the largest producers and distributers of
premium quality branded food.

9. An Overview of the Issues
 In 2009, the gross profit decreased but Heinz net income
increased.
 In 2010 the gross profit increased and was the higher than
the 2008 total but net income decreased.
 This is why the financial analyst had a hard time coming up
with the cost of capital, the numbers weren’t consistent to
come up with a value.

10. Heinz three years Comparative Income Statement
Year 2008 Year 2009 Year 2010
Revenue 9,885,556 10,011,331 10,494,983
Costs of goods sold 6,233,420 6,442,075 6,700,677
Gross profit 3,652,136 3,569,256 3,794,306
SG&A expense 2,081,801 2,066,810 2,235,078
Operating income (EBIT) 1,570,335 1,502,446 1,559,228
Interest expense 323,289 275,485 250,574
Other income (expense) (16,283) 92,922 (18,200)
Pre-tax Income 1,230,763 1,319,883 1,290,454
Income taxes 372,587 375,483 358,514
Net income after taxes 858,176 944,400 931,940
Adjustments to net income (13,251) (21,328) (67,048)
Net income 844,925 923,072 864,892
Diluted EPS 2.61 2.89 2.71
Dividends per share 1.52 1.66 1.68

11. Heinz Stock price
 In the middle of 2008 the stock price of Heinz was of $50 per share
but when the economy took a hit, prices fell just above $20 per
share.
 Recession’s certainty could wreak havoc on financial markets and
after 2008 the interest rates dramatically changed as they were
lower than usual.
 When measuring over a long period of time, the average premium
had been about 7.5% when measured over a shorter period, and
varied greatly as the premium had been closer to 6% and lower
measured by others.
 CFO’s survey result revealed that there are expectations for an
even lower premium in near future, close to 5%.

12. Recap through the Market
Years Operating
Income
Sales Cash flows Dividends
2005 $1.4 million about $9 million $920 million.
2006 $1.1 million $8.7 million $4.2 billion
2007 $1.4 million $9 million
2008 $1.5 million $10 million $1.8 billion
2009 $1.5 million $10 million %880 million
2010 4.6

13. 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.

14. Contents
 Presenter1: Iqra
 Introduction
 Background
 Company’s overview
 Issues faced by
Heinz
 Heinz stock price
 Problem statement
 Presenter 2: Sadia
 Questions
Overview
 Question 1
Solution
 Question 2
Solution
Presenter 3: Adeel
Questions Overview
Question 3 Solution
Comparative analysis
discussion
Concluding Remarks

15. Questions to be Answered
 What were the yields on the two representative outstanding
Heinz-debt issues as of the end of April 2010? What were
they one year earlier?
 2. What was the WACC for Heinz at the start of fiscal year
2010? What was the WACC one year earlier?
 3. What is your best estimate of the WACC for Kraft Foods,
Campbell Soup Company, and Del Monte Foods? How do
these WACCs influence your thinking about the WACC for
Heinz?

16. Addressing Problem Question 1:
What were the yields on the two representative
outstanding Heinz-debt issues as of the end of
April 2010? What were they one year earlier?

17. Heinz Balance Sheet Liabilities
2009 2010
Liabilities
Accounts payable 1,113,307 1,129,514
Short-term debt 61,297 43,853
Current portion of long-term debt 4,341 15,167
Other current liabilities 883,901 986,825
Total current liabilities 2,062,846 2,175,359
Long-term debt 5,076,186 4,559,152
Other noncurrent liabilities 1,246,047 1,392,704
Total Liabilities 6,322,233 5,951,856

18. Heinz Capital Market Prices of Typical Issues
2009 2010
$ $
Heinz stock price 34.42 46.87
Heinz Bond Price:
Bond price: 6.750% coupon , semiannual bond due 3/15/32
(BBB rated)
91.4 116.9
Bond price: 6.625% coupon, semiannual bond due 10/15/12
(BBB rated)
116.5 113.7

19. Yield to maturity (YTM)
 Bond's yield to maturity (YTM) is the internal rate of return required
for the present value (pv) of all the future cash flows of the bond
(face value and coupon payments) to equal the current bond price.
YTM assumes that all coupon payments are reinvested at a yield
equal to the YTM and that the bond is held to maturity.
 The YTM method YTM is an appropriate estimate of the long-term
cost of debt as it measures the rate of return paid to bondholders if
the bond is held until maturity.

20. yield to maturity (YTM)
 Yield to maturity (YTM) is the total return anticipated on a
bond if the bond is held until it matures. Yield to maturity is
considered a long-term bond yield but is expressed as an
annual rate. In other words, it is the internal rate of return
(IRR) of an investment in a bond if the investor holds the bond
until maturity, with all payments made as scheduled and
reinvested at the same rate.
 Yield to maturity is also referred to as "book yield" or
"redemption yield."

21. Yield to Maturiy (Cont’d)
 YTM-approx.= ( C +F –P) / n
( F + P) / 2
Semi-annual YTM= 2 * YTM
C= Coupon / interest payment
F=Future Value
P=Present Value
N= Years to maturity

22. Undelying Assumptions for Case Solution Q1 Yield
to Maturity
• To calculate YTM Face value (F) of Bonds is considered
$100.
• When determining the YTM for the 2 bonds, the long term
rates were selected for this analysis. One of the bonds
has 22 years remaining, rather than taking an average of
the short and long

23. Heinz Co: Yield to Maturity (YTM ) For the Year 2010
Long term Bond Short Term Bonds
Face Value (F) 100.00 FV 100.00 FV 100.00 FV 100.00
Market Price ( P) 116.90 PV (116.50) Price 113.70 PV (113.70)
Maturity 22.00 NPER 44.00 Maturity 2.00 NPER 4.00
Coupen/Interest
Payment 0.07 PMT 3.38 Coupen 0.07 PMT 3.31
PMT=Coupen rate*
(Face Value /2)
PMT=Coupen
rate* (Face
Value /2)
Rate
(6.75%*(100/2)=
Rate
(6.625%*(100/
2)=
YTM- Yield to
Maturity YTM 2.73%
YTM- Yield to
Maturity YTM -0.10%
YTM- Semi annual:
Rate*2
5.45% YTM- Semi
annual: Rate*2 -0.21%
Excel Formula Calcuation YTM: rate (nper,pmt,pv,fv)

24. Heinz Co: Yield to Maturity (YTM ) For the Year 2009
Long term Bond Short Term Bonds
Face Value (F) 100 F 100Face Value (F) 100 FV 100
Market Price ( P) 91.4 P -91.4Market Price ( P) 116.5 PV -116.5
Maturity 22 NPER 44Maturity 2 NPER 4
Coupen/Interest
Payment 6.75% PMT 3.375Coupen 6.625% PMT 3.3125
PMT=Coupen
rate* (Face Value
/2) 3.375
PMT=Coupen
rate* (Face Value
/2)
Rate
(6.75%*(100/2)=
Rate
(6.625%*(100/2)=
YTM- Yield to
Maturity YTM 3.78%
YTM- Yield to
Maturity YTM -0.74%
YTM- Semi
annual: Rate*2 7.56%
YTM- Semi
annual: Rate*2 -1.47%
Excel Formula Calcuation YTM: rate (nper,pmt,pv,fv)

25. Question 2:
What was the WACC for Heinz at the start of fiscal year 2010? What was the
WACC one year earlier?
WACC E/(V)*Cost of Equity + D/(V)*Cost of Debt*(1 - Tax Rate)
WACC (E/V)*Re+ (P/V)*Rp+ (D/V)* Rd(1-TC)
WACC: is a combination
of financing
businesses through both
debt and equity.

26. Undelying Assumptions for Case Solution Q2
WAAC for Heinz
Market Risk Premium ( RM-RF) 7.5%
Beta 0.62
Tax Rate( inc. Satement %)
2009 28.4%
2010 27.9%
R (f ) based on Based on data of 10 year US
Bonds as risk free rate
0.369
Representative yield on long-term debt
2009 7.56%
2010 5.45%

27. Undelying Assumptions for Case Solution Q2
WAAC for Competitors
Market Risk Premium ( RM-RF)
7.5% Beta
Kraft 0.58
Cambell Soup 0.32
Dell Mont 0.72
Tax Rate U.S Fed 35%
R (f ) based on Based on data of 10 year US
Bonds as risk free rate 0.369
Representative yield on long-term debt
Kraft 5.12%
Cambell Soup 4.36%
Dell Mont 6.19%

28. Heinz Co WACC % Calculation
 The weighted average cost of capital (WACC) is the rate that a company is expected to
pay on average to all its security holders to finance its assets. The WACC is commonly
referred to as the firm's cost of capital. Generally speaking, a company's assets are
financed by debt and equity. WACC is the average of the costs of these sources of
financing, each of which is weighted by its respective use in the given situation. By taking a
weighted average, we can see how much interest the company has to pay for every dollar it
finances.
 The Weighted Average Cost of Capital (WACC) is the market value weighted cost of debt
and equity, and is calculated as follows:
 WACC=E/V*Cost of Equity+D/V*Cost of Debt*(1 - Tax Rate)
 (E/V)*Re+ (P/V)*Rp+ (D/V)* Rd(1-TC)
 Rd = cost of debt , E = market value of the firm’s equity , D = market value of firm’s debt
 V = E + D , E/V = % of financing that is equity , D/V = % of financing that is debt , Tc =
corporate tax rate

29. Major Components of WACC
 Market Value of Debt and Equity
 Cost of Debt and Equity
 Beta Component
 Risk Free Rate and Market Premium
 Taxation
 Cash Flow Projections

30. Heinz Co WACC % Calculation
 WACC=E/(V)*Cost of Equity+D/(V)*Cost of Debt*(1 - Tax Rate)
 (E/V)*Re+ (P/V)*Rp+ (D/V)* Rd(1-TC)
 1. Return on Equity Calculation ( E/(V)*Cost of Equity )
 ( E/V)*Re
Re=Rf + B*(Rm) - E (Rf)
MARKET Risk premium=RM-RF
CAPM = RF+B (RM-RF)
E= Equity

31. E/(V)*Cost of Equity
Heinz Kraft
Campbell Del
2009 2010 Soup Monte
Market Risk Premium ( RM-RF) 7.50% 7.50% 7.50% 7.50% 7.50%
Beta 0.62 0.62 0.58 0.32 0.72
R(f) 0.369 0.369 0.369 0.369 0.369
Re=Rf + B* (Rm-Rf) 0.42 0.42 0.41 0.39 0.42
E=Equity ( Market based ) 10,837 14,890 51876.5 12937.32 2746.998
V 15,979 19,508 96,839 16,289 5,864
E/V ( Market value based ) 68% 76% 54% 79% 47%
(E/V)*Re
0.28 0.32 0.22 0.31 0.20

32. Heinz Co WACC % Calculation
WACC=E/(V)*Cost of Equity+D/(V)*Cost of Debt*(1 - Tax Rate)
(E/V)*Re+ (P/V)*Rp+ (D/V)* Rd(1-TC)
 2. D/(V)*Cost of Debt*(1 - Tax Rate) Calculation

33. (D/V)* Rd(1-TC)
Heinz Kraft
Campbell Del
2009 2010 Soup Monte
Tax rate 0.284 0.278 0.35 0.35 0.35
1-TC 72% 72% 65% 65% 65%
D-Long term debt 5,141.82 4,618.17 44,962 3,352 3,117
E+ D= Equity + Debt 15,979.31 19,508.30 96,839 16,289 5,864
D/ D+ E 32% 24% 46% 21% 53%
Rd=Yield Return on Debt 7.56% 5.45% 5.12% 4.36% 6.19%
(D/V)* Rd(1-TC) 0.02 0.01 0.02 0.01 0.02

34. (WAAC)= WACC= (E/V)*Re+ (P/V)*Rp+ (D/V)* Rd(1-TC)
Heinz
Kraft
Campbell Del
2009 2010 Soup Monte
a. (E/V)*Re 0.28 0.32 0.22 0.31 0.20
b. (D/V)* Rd(1-TC) 0.02 0.01 0.02 0.01 0.02
WAAC 0.30 0.33 0.24 0.32 0.22

35. Workings Notes: WAAC
Heinz
Kraft
Campbell Del
2009 2010
Shares outstanding (in millions) 314.86 317.69 1,735 363 182
Share price (dollars as of close April
30, 2010) 34.42 46.87 29.90 35.64 15.11
Market Value of Equity 10,837 14,890 51876.5 12937.32 2746.998

36. Workings Notes: WAAC
Heinz Kraft
Campbell Del
2009 2010
Book Value of Debt
Short-term debt 61 44
Current portion of long-term debt 4 15 25,972 728 1,827
Long-term debt 5,076 4,559 18,990 2,624 1,290
Total 5,142 4,618 44,962 3,352 3,117

37. Contents
 Presenter1: Iqra
 Introduction
 Background
 Company’s overview
 Issues faced by
Heinz
 Heinz stock price
 Problem statement
 Presenter 2: Sadia
 Questions Overview
 Question 1 Solution
 Question 2 Solution
Presenter 3: Adeel
Questions Overview
Question 3 Solution
Comparative
analysis discussion
Concluding
Remarks

38. Q3.What is your best estimate of the WACC for
Kraft Foods, Campbell Soup Company, and Del
Monte Foods? How do these WACCs influence
your thinking about the WACC for Heinz?

39. Heinz Position Vs Competitor Analysis
Heinz Kraft
Campbell Soup Del Monte
Year 2009 Year 2010
Long-term debt 5,141.82 4,618.17 44,962.00 3,352.00 3,117.00
V 15,979.31 19,508.30 96,838.50 16,289.32 5,864.00
E ( Market Value ) 10,837.48 14,890.13 51,876.50 12,937.32 2,747.00
Debt to V 32% 24% 46% 21% 53%
Equity / V 68% 76% 54% 79% 47%
Debt to Equity 47% 31% 87% 26% 113%
Representative yield
on long-term debt 7.56% 5.45% 5.12% 4.36% 6.19%
Share price (April 30,
2010) 34.42 46.87 29.90 35.64 15.11
WAAC 0.30 0.33 0.24 0.32 0.22

40. Heinz Position Vs Competitor Analysis
 The estimated WACC for the competitors (Kraft Foods, Campbell Soup, and Del
Monte) are as follows: 0.24 , 0.32 , 0.22 .
 The WACC of Heinz Company for the year 2010 is 0.33 which is highest than
competitors. This shows that investors of Heinz Company are demanding
greater return as compared to its competitors.
 However, the calculation of WACC for each company is based on certain
assumptions like for Heinz food Company’s beta is used and risk free rate and
market premium rate are also based upon assumptions. Nonetheless,
approximately same assumptions are used for the calculation of WACC of other
three companies. Therefore, the WACC of Heinz is clearly overestimated as
compared to its competitors WACC.

41. Heinz Position Vs Competitor Analysis (Cont.…)
 In order for investor to invest their money into a company,
they should look
 for companies that have lower WACC ratio than its rate of
return.
 By comparing Heinz’s WACC and its competitors, we can see
that Heinz’s WACC is in line with the industry.
 which indicates that WACC is investing in its capital more
efficiently.
 Debt to equity ratio of Del Montand craft are also higher than
Heinz.

42. INFLUENCE ON OUR THINKING
 Here we have calculated WACC values and these values represent that how
companies are utilizing their resources.
 When a company increases its debt to equity ratio, it increases the burden of
interest as well, which can result in higher WACC value.
 In the case of Kraft Food their debt to Equity Ratio is 87% and their WACC is
highest among others.

43. Conclusion
 The stock price of Heinz increased in 2010 while the S&P 500 increased
 35%. The increase in share price directly explains the increase in Market Value
and Equity in the company.
 The ratio of debt to equity is reduced primarily because the equity component
increased with share value. the ratio of debt and equity are primary components
in calculating WACC.
 Being that the entire market dropped in 2009 and increased in 2010, we
determined that the change in WACC is not artificially induced and it is
appropriate to adjust the rate for Heinz as a corporation.
 The 2010 WACC falls in line with the industry and the closet competitors and is
reflective of
 what the firm will likely face in the future.