H J Heinz: Estimating the cost of capital Harvard Case Solution & Analysis

H J Heinz: Estimating the cost of capital Case Solution

Introduction:

H.J Hein was incorporated in Pennsylvania in 1900.It operates in partnership under the same name which was developed in 1869 as a food business in Sharpsburg, Pennsylvania. The company has succeeded in subsidiaries manufacturing and marketing of line of processed food and related products and services throughout the world.

The firm’s products were sorted out into two core businesses: meal enhancers and snakes. Heinz dispersed its products through its own particular sales force, free intermediaries, operators, and wholesalers to chain, autonomous basic supply accounts, mass traders and etc.

The competitors include Kraft Foods, Campbell Soup Company and Del Monte Foods as well as other global food industry giants such as Nestle and Unilever.

Problem statement:

The company has been considering several investment proposals and expansion projects through food products. The main concern is regarding the company’s cost of capital. The cost of capital plays an important role and it is an important part in the capital budgeting. The weighted average cost of capital has been in a debate because of certain issues.

Firstly, the stock prices of the company have been volatile and they reduced and then increased again at the same position, hence it was a debate to make regarding any changes as the price was back to the same position (i.e. $ 47).

Secondly, there is low interest rate prevailing in the market, which has reduced the cost of capital, and allowed the project to be accepted due to favourable event. Lastly, the economy is still in financial melt-down and thus, there are concerns over risk assessment which might affect the WACC of the company.

Along with this, the company would have to face strong competition from Kraft Foods, Campbell Soup and Del Monte Foods as they are largest producers and distributors of high quality branded foods.

The company’s financial analyst, Solomon Sheppard, in North American Consumer Products Division, was given the task to identify the reliable estimate of company’s Weighted Average Cost of Capital. He was asked to recommend WACC in order to be used in making the decision on the investment proposals.

Calculations Findings and discussion:

The company’s situation in 2009:

There was fluctuation in stock price in 2008 as it was $47 and in 2009 it reduced to $34. The company was doing well in 2009 and 2010 as it was having positive growth in sales and there was an increase in profits. In 2009, the company’s gross profit decreased however,the net income increased. In the current year 2010, the company increased its gross profit however, the net income decreased, which gave a difficult time to the financial analyst to calculate the cost of capital and resulted in inappropriate values due to inconsistent numbers.

In 2009, the stock price declined due to recession in the stock market as well as the interest rates reduced.Moreover,the average market premium reduced from 7.5% to 6% and the analysts expected further decline in premium in 2009.

In order to cope up with this situation, the company decided to increase its revenue by accepting and creating more new projects since the net income was $923,072 in 2009 and $864892 in 2010 (reduced in 2010)......................

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