PART A: Description of the Assignment

WACC

Case Study: H.J. Heinz: estimating the Cost of Capital in Uncertain Times

1. What was the WACC for Heinz in fiscal year 2010 and 2009.

State and explain the assumptions used. (25 marks)

Discussion of assumptions and sources 20 marks

Calculation of WACC 5 marks

Students will need to show all their workings for questions 1. It is not sufficient to simply state the result of your calculations. Given

the range of input data when calculating WACC, you should demonstrate your understanding of how the various elements fit into the

calculations and justify the choices you have made.

• Use CAPM to calculate Cost of Equity

Justify the choice of Return on market base on historical dataS&P 500 Index.

• Calculate the Cost of Debt by Average Interest Paid/Average Debt. Justify the assumptions by using Yield to Maturity (YTM).

WACC calculation in Excel is required.

2. As pointed out in the case study, Solomon Sheppard was determined to quantify the WACC of Heinz to see the real cost of capital of

the firm. But he saw that WACC is subject to change depending on the range of inputs. Critically analyse the advantages and disadvantages

in using WACC as a quantitative method for arriving at the opportunity cost of capital. (20 marks)

Question 2 is asking you to describe, define and quantify the use of WACC by corporations. Students should demonstrate their understanding

of its strengths and weaknesses and the appropriateness, if any, of alternative methods. In your answers, in addition to the information

from the Case Study, please apply the concepts from the appropriate areas of financial and economic theory, discussed during this and all

previous modules during your course. Your answers should include appropriate numerical data and, if appropriate, charts/graphs.

3. Given interest rates in 2010 were at historic lows and have remained low since, it might be advantageous for Heinz and other companies

to dramatically increase the amount of debt on their balance sheets. Explain the advantages and disadvantages of doing so in the context

of the theories of Modigliani and Miller and others. (20 marks)

Question 3 is clearly about debt and optimum capital structure and as such, students should discuss the advantages and disadvantages of

debt and equity. MM theories should underpin your analysis as well as any other relevant financial and economic theory.(Remember to use

the theories of Modigliani and Miller)

See next page for PART B

PART B: Description of the Assignment Net Present Value: Heinz Healthy Soups

After arriving at a suitable WACC, Solomon Sheppard decided to evaluate a new project:

Heinz was considering whether to develop a new range of healthy eating options, as their customer base had expressed a preference for food

with lower sugar and fat content. Consequently, after a marketing report which cost $100,000, Sheppard asked his team to draw up some

financial plans to build up a new business, Heinz Healthy Soups, near their headquarters in Pittsburgh, Pennsylvania.

With a lifetime of 5 years, the project would include initial investments in new equipment, packaging and other fixed assets, totalling

$70 million, to be depreciated over 5 years, using straight-line depreciation. At the end of the project, the equipment will be sold for

$6 million. Heinz already has available warehouse capacity needed for this new venture, in Pittsburgh. The new venture will occupy 10% of

this warehouse. The warehouse is rented at a annual cost of $30 million. The wages for the project will be $15 million in the first year,

rising by 2% per year for each subsequent year of the project; 20% of staff will be transferred from other Heinz businesses (they will not

need to be replaced). Distribution costs will be 1% of sales of the new product.

In the first year, Heinz expects to sell 10% of the current quantity of non-healthy soups sold in supermarkets. In the following years,

this will increase to 30%. However, as a consequence of launching this new product, it is expected that sales of the existing non-healthy

soup sales will go down. Sales in the traditional soups will are expected to decrease from $1.5 billion a year to $1.4 billion a year for

the next 5 years.

The new soup range is a premium product. So it is expected that prices will be 5% higher than the tradition products. However, the cost of

goods sold is anticipated to remain at 80% of sales. Heinz expects to spend $10 million now on advertising this new product and $20

million in the first year of the product launch.

Accounts are payable in 15 days and the inventory corresponds to one month of sales. Accounts are receivable in 30 days.
It is assumed

that the tax rate will be equivalent to Group tax.

4. Calculate a Profit and Loss statement for the project. (12 marks)

Question 4 is asking you create a Profit and Loss statement from the information given in the text. You will have to take into account the

various cost items of the project to arrive at a profit figure for each year.

5. Calculate the FCFF of the project, taking into account the annual working capital requirements of the project. (8 marks)

Question 5 asks you to create a separate calculation for to arrive at a FCFF for the project. You will have to take into account the

various items of Working Capital (preferably shown in a separate calculation), as well as all the other costs, to arrive at a cash-flow

figure for each year. This also requires you to show all your workings.

6. Calculate and analyse the project’s NPV, IRR, payback period and discounted payback period.

(15 marks)

Question 6 also requires you to show all your workings to arrive at various indicators of the project’s return. You should use the WACC

that you have calculated in Question 1 for the purposes of discounting the free cash flows. This WACC can be adjusted, or not, according

to your thinking about the project’s risk profile.

1 Excel File required showing calculation of the WACC and Part B (P&L statement, FCFF, NPV, IRR, Payback Period and Discounted Payback

Period)

Please read the Case Study and Annual Report carefully to answer the Qs and could find appropriate figures in there.