Homework 2 H. J. Heinz: Estimating the Cost of Capital in Uncertain Times A portion of your grade will be based on the clarity of your presentation. Please hand the homework in online prior to the...

Homework 2

H. J. Heinz: Estimating the Cost of Capital in Uncertain Times

• A portion of your grade will be based on the clarity of your presentation.

• Please hand the homework in online prior to the start of the synchronous class. Keep a copy for reference during class discussion.

In April 2010, you have been asked to estimate the weighted average cost of capital (WACC) for Heinz. Please provide a brief summary (three pages maximum) of your analysis and recommendations. Your analysis should be directed to the CFO of Heinz, who is evaluating numerous investment proposals.

Your analysis should be sufficiently detailed that the CFO can understand both the calculations and logic behind your recommendations. Your report should cover the following basic issues: cost of debt, cost of equity, the market risk premium, and Heinz’s risk relative to the market. In addition, you should answer the following questions:

1. How precise is your estimate of Heinz’s cost of capital?


2. An important input into Heinz’s cost of capital is the expected market risk premium. If the financial crisis reduced investors’ appetite for risk (i.e., increased investors’ aversion to risk), how might you adjust the expected market risk premium to reflect this increased risk aversion?

NOTES: To simplify calculations, you may assume the following:

• In practice, most firms use 10-year U.S. government bond rates as an estimate of the risk-free rate when calculating WACC. In keeping with this practice, use 10-year U.S. government bonds as your risk-free rate.


• The book value of short-term debt is equal to the market value of short-term debt; the book value of long-term debt is equal to the market value of long-term debt.


• Short-term debt has a yield similar to the 2011 debt issue (Exhibit 3).


• Long-term debt has a yield similar to the 2032 debt issue (Exhibit 3).


• Use only information provided in the text, lecture notes, case, and associated spreadsheet. There is no need to obtain additional data from the Web.