Integrative Case: Henkel AGCost of Cost Capital Valuation The Cost of Capital at Henkel AG Professor David Wessels ©2010 The Wharton School of the University

Integrative Case: Henkel AG Cost of Cost Capital

ValuationThe Cost of Capital at Henkel AG

Professor David Wessels ©2010

The Wharton School of the University of Pennsylvania

3620 Locust Walk, Philadelphia PA 19104


The Cost of Capital at Henkel

• To value Henkel using DCF and to evaluate Henkel’s ability to create

value, we need a robust estimate of the company’s cost of capital.

• Based on today’s low interest rates (the 10-year German Treasury trades at

just 3.4%), we estimate Henkel’s after-tax cost of capital at 6.6%. This

estimate is based on a cost of debt of 3.2% (using a default rating of A-), a

cost of equity of 7.5% (using a relevered industry beta of 0.82), and a debt-

to-value ratio of 22.0%.

• In this presentation, we step through the calculation of each component.

We start with the cost of debt, followed by the cost of equity, and conclude

with a short discussion on the company’s capital structure.

Valuation, Measuring and Managing the Value of Companies 2


The Cost of Capital


• Yield to maturity of 10-year German Treasuries

• German statutory tax rate reported by the company

• Yield to maturity of 10-year German Treasuries

• Estimated using betas from industry comparables

We assume Henkel will maintain its current 22.0%

debt-to-value ratio.

• We estimate the after-tax cost of capital for Henkel at 6.6%. The cost of capital is

historically low, driven primarily by low interest rates (only 3.4% for 10-year German

Treasuries) and a low beta for Henkel (estimate at 0.82).

Cost of capital:

6.6%

After-tax cost of debt: 3.2%

Cost of debt:

4.6%

Marginal tax rate:

31.0%

Cost of equity:

7.5%

Risk-free rate:

3.4%

Industry beta:

0.82


Credit Ratings• Since Henkel does not carry long-term debt, use the company’s credit rating to

determine the cost of debt. As of its last rating, the company was rated A-,

which translates to a yield-to-maturity of 4.63%.


Henkel Credit RatingsRating Actions

S&PAgency Date Rating Equivalent

Moody's Jul-09 A3 A-

S&P May-09 A- A-S&P Apr-07 A A Fitch Nov-05 A- A-S&P Oct-04 A- A-S&P Apr-04 A- A-S&P Dec-03 A+ A+

4.13%

4.49%

4.52%

4.74%

5.08%

5.58%

8.03%

AA

AA-

A

BBB+

BBB

BBB-

BB

Yield by Debt RatingEuropean Industrials, 2009

A-estimated at

4.63%


After-Tax Cost of Debt

• Since interest is tax deductible, and

this deduction is not included in

free cash flow or ROIC, it must be

incorporated into the cost of debt.

• In 2009, Henkel paid a marginal

tax rate of 31%. Therefore, we

reduce the cost of debt from 4.6%

to 3.2 percent.


40% 40% 40%

31% 31%

0%

10%

20%

30%

40%

50%

2005 2006 2007 2008 2009

Henkel AGMarginal tax rate

After-tax cost of debt = (1-31%) (4.63%)


The Risk Free Rate

• To calculate the cost of equity for

Henkel AG, we start with a euro-

denominated 10-year German

Treasury rate.

• Use a risk-free rate from the same

currency as the company’s cash

flows to properly account for

imbedded inflation (in both the cash

flows and the cost of capital).

• In 2010, the 10-year Germany

Treasury rate was 3.38%.


2.7%

3.9%

4.6%

2.5%

3.4%

4.2%

0%

1%

2%

3%

4%

5%

1-Year 2-Year 5-Year 10-Year 20-Year

Maturity

Treasury RatesYields to maturity, 2009

USD

EUR

10-Year German Treasury


Cost of Equity: Unlevered Beta

• To compute the cost of equity, we

rely on the CAPM, which in turn

requires beta. To calculate beta, we

first unlevered each company in the

European HPC industry (as defined

by JP Morgan).

• Henkel’s unlevered beta of 0.59 is

at the upper range of its

competitors. The relatively high

unlevered beta is a factor of a high

levered beta and a low level of

debt.


Henkel AG Cost of Capital

European HPC Betas1

OLS Bloomberg Debt-to Unlevered

Company Beta Adjustment2 Equity Beta

Beiersdorf AG 0.29 0.53 -0.15 0.62

Givaudan SA 0.41 0.60 0.33 0.46

Henkel AG 0.73 0.82 0.28 0.64

L'Oreal SA 0.49 0.66 0.06 0.62

Oriflame Cosmetics 1.38 1.25 0.01 1.24

Reckitt Benckiser plc 0.20 0.47 0.00 0.47

Svenska Cellulosa AB 0.73 0.82 0.63 0.50

Unilever plc 0.52 0.68 0.14 0.60

0.64

1Levered beta calculated using OLS regression on 10 years of

monthly data, Bloomberg adjustment


Beta Calculations by Segment

• To calculate a cost of capital by segment,

we look to industry competitors on a

broader scale.

• Although no true “pure play”

competitors exist, there is consistency

within each segment.

• The unlevered beta is lowest for

“Laundry & Home Care” (0.44) and

highest for “Adhesives” (0.71). This is

consistent with the stability of consumer

staples and the cyclical nature of

adhesives.


Henkel AG Cost of Capital

Segment betas

OLS Bloomberg Debt-to Unlevered

Company Beta Adjustment Equity Beta

Henkel AG 0.73 0.82 0.28 0.64

Clorox 0.21 0.47 37.7% 0.34

Procter & Gamble 0.21 0.47 22.1% 0.38

Unilever 0.52 0.68 13.9% 0.60

0.44

Beiersdorf 0.29 0.53 -15.1% 0.62

Colgate-Palmolive 0.36 0.57 9.4% 0.53

Estee Lauder 0.90 0.93 8.7% 0.86

0.67

3M Company 0.62 0.74 7.1% 0.69

Avery Dennison 0.91 0.94 45.3% 0.65

Fuller (H B) 0.87 0.91 16.7% 0.78

0.71



• To determine the cost of equity, we

relever industry betas to Henkel’s debt-

to-equity ratio. We then apply the

capital assets pricing model:

Cost of Equity by Segment

f m fCost of equity = r + b E R - r

using a risk free rate of 3.38% and a

market risk premium of 5%.

• Based on a levered beta of 0.64, we

estimate the cost of equity for Henkel

AG at 6.6%.

7.5%

6.2%

7.7%

7.9%

Henkel AG

Laundry & Home Care

Cosmetics & Toiletries

Adhesives

Cost of EquityDiscount rate, based on 2009 comparables


Capital Structure

• To create the weighted average cost of capital, we weight the cost of debt and

cost of equity by the market values of debt in equity. For Henkel, debt

comprises 22.0% of the total enterprise value.


4.2

0.8

5.0

1.2

3.8

13.4

17.2

0

5

10

15

20

Totaldebt

Unfundedretirements

Debt &equivalents

Cash Net debt Market capitalization

Enterprise value

$ bi

llion

s

Henkel AG Capital Structure$ billions

Henkel AG Cost of CapitalCapital Structure

$ billions percentNet debt 3.8 22.0%Market capitalization 13.4 78.0%Enterprise value 17.2 100.0%

Documents

Integrative Case: Henkel AGCost of Cost Capital Valuation The Cost of Capital at Henkel AG Professor David Wessels ©2010 The Wharton School of the University