Costs of Capital Exercise

Costs of Capital

Costs of Capital

e = Cost of Common Equity

(

OTE: This is the before-tax cost of debt)

ed Average Cost of Capital

.

Michael Dimond: from treasury.gov for date of interest

20 TREASURY 20-Yr CMT on filing date

(also multiples for relative valuation)

Beta Debt

Tax Rate

Michael Dimond: Unlevered Beta = Beta divided by (1+ D/E*(1-tax rate))

to EBITDA

1.16

K

Michael Dimond: From “Comparable Firms” table

Unlevered Beta

(Kd) and

not yet…

2.43% Cost of Debt
Market Value of Debt
N 20

327

150

Value Weight
– 0

– 0 MV Equity

– 0

Ke

1.91% 2.43%

0.00% 0.00%

Michael Dimond: Given in billions

K

Ku = Unlevered Cost of Capital (sometimes called the Unlevered Cost of Equity)

Kpfd = Cost of Preferred Equity

Kd = Cost of Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper

Debt

N

WACC =

Weight

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%

Rf (Risk-free Rate)

source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrateYear&year=

20

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 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper

Beta

Ticker

Equity (Market Cap)

Unlevered Beta

P/E ratio

P/S ratio

EV/EBITDA ratio Michael Dimond: Enterprise

Value

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

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.

0.60

9.21

20.29

2

2.43%

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

Ku (Unlevered Cost of Capital)

Unlevered Cost of Capital is computed using a CAPM variation: Ku = Rf + Unlevered_Beta * (MRP)

Cost of Debt

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.

based on Altman Z-Score Michael Dimond: http://pages.stern.nyu.edu/~ealtman/z-metrics http://pages.stern.nyu.edu/~ealtman/3-%20CopCrScoringModels 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

… 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.

The cost of debt is necessary to estimate the market value of total 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

Assumed Years to maturity

Operating Leases

PV of Operating Lease Expenses

Expected Op. Lease Payments:

Y1

Y2

Y3

Y4

Y5

Y6

Y7

501

327

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)

MV Debt

Wd =MV Debt / MV Total Capital

We =MV Equity / MV Total Capital

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 <

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.

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 http://pages.stern.nyu.edu/~ealtman/3-%20CopCrScoringModels 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: Converted from millions to billions