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WACC

Procter&Gamble:CostofCapital

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WhyP&Gs

WACC?

Largeclientwantedtoenterhouseholdproductsandcompete

withP&G

detergents,

soaps,

cleansers,

and

personal

care

Cost

of

capital

of

the

client

not

feasible

due

to

Highlydiversifiedconglomerateunrelatedbusiness

OverallWACC

not

useful

for

existing

subsidiaries

OverallWACCnotusefulfornew

business

consumerproducts

Laundry

and

cleaning

products

35%

Personal

care

products

49%

Foodand

beverage

s

15%

Pulpand

chemicals

1%

Sales

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NeedforWACC

Evaluate

/

reevaluate

thenew andexistinginvestmentsrespectively

Earnmorethanhurdle

rate

Comparedifferentwaysoffinancingits

operations

Keyvariableforvaluationmodels

Ko=(ke*we)

+(kd*(1

t)*we)

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Costof

Debt?

Interest bearing debt on Books 3,331

Interest Expenses - 1989 391

Traded Coupon issues 8.25%

YTM (close to Aaa 9.22%) 9.18% Why not 9.22%?

Year to maturity 15

Bond price 92.25 Exhibit 1 Panel D

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds

5-Year 7.75 8.12 8.42

10-Year 7.84 8.21 8.47

30-Year 7.90 8.26 8.50Corporate Bonds by Moody's Rating

Aaa 8.86 8.99 9.22

Aa 9.11 9.27 9.45

A 9.39 9.54 9.75

Baa 9.82 9.94 10.14

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Costof

Debt?

Interest bearing debt on Books 3,331

Interest Expenses - 1989 391

Traded Coupon issues 8.25%

YTM (close to Aaa 9.22%) 9.18% Why not 9.22%?

Year to maturity 15

Bond price 92.25 Exhibit 1 Panel D

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds

5-Year 7.75 8.12 8.42

10-Year 7.84 8.21 8.47

30-Year 7.90 8.26 8.50Corporate Bonds by Moody's Rating

Aaa 8.86 8.99 9.22

Aa 9.11 9.27 9.45

A 9.39 9.54 9.75

Baa 9.82 9.94 10.14

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Costof

Equity

Past 10 Years Past 5 Years Estimated Next 5 Years

Sales 7.60 10.20 8.00Earnings 7.00 5.90 15.50

Dividends 6.50 4.60 11.00

Gorwth Rate

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds

5-Year 7.75 8.12 8.42

10-Year 7.84 8.21 8.47

30-Year 7.90 8.26 8.50

Corporate Bonds by Moody's Rating

Aaa 8.86 8.99 9.22

Aa 9.11 9.27 9.45

A 9.39 9.54 9.75

Baa 9.82 9.94 10.14

1989 Dec 1990 Jan 1990 Feb

Money Market Rates

CP (3 Months) 8.32 8.16 8.22

Eurodollar Deposits ( 3 Months) 8.39 8.22 8.24

US Treasury Bills

3 Months 7.63 7.64 7.74

1 - Year 7.21 7.38 7.55Prime rate charged by Banks 10.50 10.11 10.00

1988 1989

Current stock price 126.25

No. of shares (Millions) 170

Market Cap (Millions) 21462.5

Book Value of Equity 6337 7076

Book Value of Debt 3364 3331

Market Value Weight of Equity 86.57%

Book Value Weight of Equity 67.99%

Traget Value Weight of Equity 65%

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Costof

Equity

Past 10 Years Past 5 Years Estimated Next 5 Years

Sales 7.60 10.20 8.00Earnings 7.00 5.90 15.50

Dividends 6.50 4.60 11.00

Gorwth Rate

1989 Dec 1990 Jan 1990 Feb

US Treasury Bonds

5-Year 7.75 8.12 8.42

10-Year 7.84 8.21 8.47

30-Year 7.90 8.26 8.50

Corporate Bonds by Moody's Rating

Aaa 8.86 8.99 9.22

Aa 9.11 9.27 9.45

A 9.39 9.54 9.75

Baa 9.82 9.94 10.14

1989 Dec 1990 Jan 1990 Feb

Money Market Rates

CP (3 Months) 8.32 8.16 8.22

Eurodollar Deposits ( 3 Months) 8.39 8.22 8.24

US Treasury Bills

3 Months 7.63 7.64 7.74

1 - Year 7.21 7.38 7.55Prime rate charged by Banks 10.50 10.11 10.00

1988 1989

Current stock price 126.25

No. of shares (Millions) 170

Market Cap (Millions) 21462.5

Book Value of Equity 6337 7076

Book Value of Debt 3364 3331

Market Value Weight of Equity 86.57%

Book Value Weight of Equity 67.99%

Traget Value Weight of Equity 65%

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ke=Rf+

(Rm Rf)

*LongTerm

vs.Short

Term

*TopDown

vs.Bottom

Up*Leveredvs.

Unlevered

*GMvs.

AM

NonTradedAssets?

PrivateFirms?

Reconstitutionof

firms?

Ifnegative?*Current?

Historical?

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Ko=(ke*we)

+(kd*(1

t)*we)

Marketvs.

Bookvs.

Target

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Leveredand

Unlevered

Beta

E

D*t)-1(+1

=

]ED*t)-1(+1[=

LU

UL

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Effectof

Leverage

on

Beta

11

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CreditRating

and

Key

Financial

Ratios

AAA AA A BBB BB B

EBIT interest coverage (x) 23.4 13.3 6.3 3.9 2.2 1

Funds from operations/total debt (%) 214.2 65.7 42.2 30.6 19.7 10.4

Free operating cash flow/total debt (%) 156.6 33.6 22.3 12.8 7.3 1.5

Return on capital (%) 35 26.6 18.1 13.1 11.5 8

Operating income/sales (%) 23.4 24 18.1 15.5 15.4 14.7LT debt/capital (%) -1.1 21.1 33.8 40.3 53.6 72.6

Total-debt/capital, incl. Short-term debt (%) 5 35.9 42.6 47 57.7 75.1

Non-Investment GradeInvestment GradeKey Industrial Financial Ratios by Credit Rating

12

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So,WhatistheWACCforP&G?

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EffectiveTax

Rate

2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

ITC 30.60% 30.57% 30.74% 31.38% 32.49% 32.37% 31.75% 31.24% 30.67% 27.61%

HUL 23.09% 23.42% 22.42% 21.49% 21.90% 16.80% 17.28% 15.18% 13.28% 19.37%

UBL 24.56% 23.38% 27.08% 31.52% 32.59% 48.10% 45.57% 51.40% 56.70% 29.85%

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15/15

IsWACCofP&GandClient

comparable?

P&Ghasa

dominantmarket

shareclientisanewentrants

Smallin

size

to

matchtheP&G

IssuesofLeverageDifferences

IssuesofBusinessRisk